After withdrawing the popular 7.75% (taxable) bonds on 28 May, the government has announced the launch of a new series of bonds with an interest rate of 7.15%. However, the rate will be reset every six months as per prevailing interest rates. The bonds will have a tenor of seven years and their interest will be taxed at your slab rate. They can be purchased from nationalized banks and specified private sector banks. Only resident Indians or Hindu Undivided Families (HUFs) can subscribe to the bonds.
The notes have a minimum subscription of ₹1,000 and you can subscribe in multiples of ₹1,000. There is no maximum limit for investment in them. The interest rate on the bonds will be paid on 1 January and 1 July every year. The first interest rate payment will be made on 1 January 2021 at 7.15%. You can also reinvest the interest to buy fresh bonds in the multiples of ₹1,000 to compound your money. However, these bonds will have a fresh tenor of seven years.
The bonds cannot be traded or used as collateral for loans. However, they can be inherited by the legal heirs of the holder. Premature redemption will be available for senior citizens in certain cases.
Financial planners have come out in favour of them. Kalpesh Ashar, founder, Full Circle Financial Planners and Advisors, highlighted the sovereign (government) guarantee behind the bonds, thus making them very low risk. He also noted the floating rate on them as a positive.
A floating rate can adjust higher when overall rates in the economy go up. This can help bondholders in times of high inflation when interest rates are generally hiked. However, when interest rates head lower, the rates on the bonds will also be reduced.
Alternatives for investors include the Public Provident Fund (PPF), National Savings Certificate (NSC), Sukanya Samriddhi Yojana (SSY) and Kisan Vikas Patra (KVP).
If you are a senior citizen, you can also invest in Pradhan Mantri Vaya Vandana Yojana (PMVVY) and Senior Citizens Savings Scheme (SCSS). Among these alternatives, only SSY, SCSS and PMVVY currently offer higher rates than the proposed bonds at 7.6% and 7.4% and 7.4%, respectively. However, SSY is only available for the parents of a girl child below the age of 10 and has a maximum deposit limit of ₹1.5 lakh per year. Similarly, SCSS and PMVVY have a maximum limit of ₹15 lakh per person and are only open to senior citizens.
“Given the current situation, these bonds are a decent offering, considering the safety aspect and no upper limit for investment. People, especially senior citizens looking to park money in safer options for a long tenure and not requiring regular monthly income (payout is biannual) can consider them," said Prableen Bajpai, founder, Finfix Research and Analytics, a wealth management firm.
Another competitor to these bonds is debt mutual funds. Debt fund returns can fluctuate based on credit quality (the risk of default) and interest rate risk (bond prices changing when interest rates change).
The proposed bonds are relatively insulated from both these factors due to their government guarantee and six-monthly interest rate reset. A third parameter of comparison is returns. Comparing the potential returns of debt funds, which are affected by credit and interest rate risk with a fixed rate product is difficult. However, a rough method of estimating debt fund returns is to look at their yield-to-maturity (YTM) minus expense ratio. The YTM for most debt funds, other than those taking on lots of credit risk currently sits in the 5-6% range. Even if we take the expense ratio to be zero, this is a great deal lower than the 7.15% on the bonds. At the shorter-end, debt funds have YTMs of 4-5%.
However, Kirtan Shah, chief financial planner, Sykes and Ray Equities (I) Ltd pointed out certain advantages of debt funds. “I think that interest rates have further room to drop, and then they will go up. This movement will be captured by both short-end funds like liquid and ultra-short as well as this product, but perhaps more efficiently by the funds," he said.
In addition, debt funds enjoy a tax advantage and a liquidity advantage, he said. Capital gains in debt mutual funds held for longer than three years are taxed at 20% and you are given the benefit of indexation. However, the interest on these government bonds will be taxable at the slab rate. Also, open-ended debt funds can be redeemed on any business day. This is not possible in case of the bonds, which have a tenor of seven years.
Senior citizens in lower tax brackets who want a fixed income can consider these bonds. However, they should be mindful of the lack of liquidity in them and the fact the monthly interest option is not available.
For those who are still building up savings and don't need regular income, a tax-free government savings instrument like PPF can deliver better value.
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