Government Bonds

The debt instruments issued by the government to raise funds and manage the money supply in the economy are known as government bonds. Central and state governments issue these instruments to raise funds for specific purposes or general money supply management. Usually, the movement of yields and trading volume of these funds indicates confidence in the economy.

There are different types of government bonds in India that vary based on the interest 

frequency, maturity, purpose, etc. Investors can understand the instrument, its types, and  suitability to seek investment. 

What are Government Bonds?

Government bonds are the securities issued by the central and state governments to finance specific objectives, raise funds or manage the monetary flow in the economy. The Reserve Bank of India (RBI) is the key authority managing its operations. These bonds help investors gain market exposure through sovereign security. These instruments function as follows:

• Investors can start government bonds investment with as low as ₹1000. This investment can be mainly made through primary and secondary markets.

• The primary issue is usually done through RBI Retail Direct, authorised bond platforms, scheduled banks, Open Market Operations (OMO), auctions, etc.
• Secondary markets are the registered bond platforms, Retail Direct, etc.

• The bonds will have specific maturity, but the investors can trade them in the secondary market.
• Moreover, bonds prescribe an interest known as a coupon rate. It indicates the regular interest that can be earned from the instrument.
• The government bond yield is different from its coupon and is determined based on the price. Also, the relationship between yield and price is inverse.

Overall, investment in government bonds can provide investors the opportunity to earn market returns, government backing, and long-term taxation benefits.

Types of Government Bonds

Investors can explore different types of government bonds in India to select the suitable one.

1. Fixed Rate Bonds

In this, the coupon rate is fixed until maturity. The bonds may differ based on the interest payment frequency, like annually or semi-annually. Usually, most government bonds have fixed rates in India.

2. Floating Rate Bonds

These types of bonds have a variable interest rate, which is set according to the market conditions in the interval of 6 months or 1 year. Investors with a potential risk appetite for changing interest rates may find it suitable.

3. Capital Indexed Bonds

These are suitable for investors willing to match their returns according to the pace of growing inflation. The capital or principal of bonds is linked to an inflation index, and it protects the principal in the long term.

4. Bonds with Call/Put Option

Similar to call/put options in the derivatives, bonds can be issued to buyback or sell. In the put option, investors have the freedom to sell the bonds on any half-yearly coupon dates. In contrast, call options allow the government to buy back the bonds from the market.

5. STRIPS or Separate Trading of Registered Interest and Principal of Securities

Here, the bond’s interest and principal are separated from the original bonds. After this separation, the bond becomes a zero-coupon bond and repays the principal at maturity. The other part continues earning interest.

6. Sovereign Gold Bonds (SGB)

As the name suggests, these bonds are an alternative to regular physical gold investments. The units represent 1 gram of gold. Investors earn 2.5% semi annual interest over the principal.

7. Sovereign Green Bonds (SGrB)

These bonds are issued for specific projects related to climate protection, and investors earn interest at 6-month intervals. This financing helps drive significant green projects with ease.

Benefits and Drawbacks of Government Bonds

Analysing the positive and negative aspects of government bond investment can help investors plan their suitability, allocations and reliability. 

Benefits	Drawbacks
It helps diversify investment into a safe asset at a minimal cost.	Varied factors affect the interest rate and yields, which decide the price during redemption.
Some bonds like SGB offer the tax exemption benefit for gains.	Their returns may be lower than other types, such as corporate bonds.
It can provide a source for regular interest income.	Usually, reinvestment risk affects the government bonds in case of falling interest rates.

Suitability Criteria for Government Bonds

Understanding what are government bonds and their types may not be enough as investors also need to analyse their suitability.

• Usually, these bonds generate lower interest than corporate bonds.
• Moreover, yields of government bonds can be affected by multiple economic and geo-political factors such as crude oil prices, tariffs, rupee appreciation/depreciation, etc.
• Investors should also check the taxation for government bonds. The interest is earned by the investor after deducting 10% ‘Tax Deducted At Source (TDS)’. Moreover, the gains at redemption are taxed as follows:

• If held for 12 months or less (short-term): tax as per income tax slab rate
• If held for more than or equal to 12 months (long-term): 12.5%

Conclusion

Investing in government bonds can be a suitable option for investors willing to focus on security for their portfolio. Moreover, there is a wide variety of types of these bonds which allow investors to select. However, government bonds are also accompanied by certain risks, and investors should analyse them before making an investment decision.Explore more insightful finance topics by logging in to PowerUp Money or downloading its financial planning app today!