Government Securities

Government Securities

Government securities(G-secs) are sovereign securities which are issued by the Reserve Bank of India on behalf of Government of India,in lieu of the Central Government's market borrowing programme.

The term Government Securities includes:

• Central Government Securities
• State Government Securities
• Treasury bills

The Central Government borrows funds to finance its 'fiscal deficit'.The market borrowing of the Central Government is raised through the issue of dated securities and 364 days treasury bills either by auction or by floatation of loans.

In addition to the above, treasury bills of 91 days are issued for managing the temporary cash mismatches of the Government. These do not form part of the borrowing programme of the Central Government.

Types of Government Securities

Government Securities are of the following types:-

Dated Securities : are generally fixed maturity and fixed coupon securities usually carrying semi-annual coupon. These are called dated securities because these are identified by their date of maturity and the coupon, e.g., 11.03% GOI 2012 is a Central Government security maturing in 2012, which carries a coupon of 11.03% payable half yearly. The key features of these securities are:

They are issued at face value.

Coupon or interest rate is fixed at the time of issuance, and remains constant till redemption of the security.

The tenor of the security is also fixed.

Interest /Coupon payment is made on a half yearly basis on its face value.

The security is redeemed at par (face value) on its maturity date.

Zero Coupon bonds are bonds issued at discount to face value and redeemed at par. These were issued first on January 19, 1994 and were followed by two subsequent issues in 1994-95 and 1995-96 respectively. The key features of these securities are:

They are issued at a discount to the face value.

The tenor of the security is fixed.

The securities do not carry any coupon or interest rate. The difference between the issue price (discounted price) and face value is the return on this security.

The security is redeemed at par (face value) on its maturity date.

Partly Paid Stock is stock where payment of principal amount is made in installments over a given time frame. It meets the needs of investors with regular flow of funds and the need of Government when it does not need funds immediately. The first issue of such stock of eight year maturity was made on November 15, 1994 for Rs. 2000 crore. Such stocks have been issued a few more times thereafter. The key features of these securities are:

They are issued at face value, but this amount is paid in installments over a specified period.

Coupon or interest rate is fixed at the time of issuance, and remains constant till redemption of the security.

The tenor of the security is also fixed.

Interest /Coupon payment is made on a half yearly basis on its face value.

The security is redeemed at par (face value) on its maturity date.

Floating Rate Bonds are bonds with variable interest rate with a fixed percentage over a benchmark rate. There may be a cap and a floor rate attached thereby fixing a maximum and minimum interest rate payable on it. Floating rate bonds of four year maturity were first issued on September 29, 1995, followed by another issue on December 5, 1995. Recently RBI issued a floating rate bond, the coupon of which is benchmarked against average yield on 364 Days Treasury Bills for last six months. The coupon is reset every six months . The key features of these securities are:

They are issued at face value.

Coupon or interest rate is fixed as a percentage over a predefined benchmark rate at the time of issuance. The benchmark rate may be Treasury bill rate, bank rate etc.

Though the benchmark does not change, the rate of interest may vary according to the change in the benchmark rate till redemption of the security. The tenor of the security is also fixed.

Interest /Coupon payment is made on a half yearly basis on its face value.

The security is redeemed at par (face value) on its maturity date.

Bonds with Call/Put Option: First time in the history of Government Securities market RBI issued a bond with call and put option this year. This bond is due for redemption in 2012 and carries a coupon of 6.72%. However the bond has call and put option after five years i.e. in year 2007. In other words it means that holder of bond can sell back (put option) bond to Government in 2007 or Government can buy back (call option) bond from holder in 2007. This bond has been priced in line with 5 year bonds.

Capital indexed Bonds are bonds where interest rate is a fixed percentage over the wholesale price index. These provide investors with an effective hedge against inflation. These bonds were floated on December 29, 1997 on tap basis. They were of five year maturity with a coupon rate of 6 per cent over the wholesale price index. The principal redemption is linked to the Wholesale Price Index. The key features of these securities are:

They are issued at face value.

Coupon or interest rate is fixed as a percentage over the wholesale price index at the time of issuance. Therefore the actual amount of interest paid varies according to the change in the Wholesale Price Index.

The tenor of the security is fixed.

Interest /Coupon payment is made on a half yearly basis on its face value.

The principal redemption is linked to the Wholesale Price Index.

Features of Government Securities

Nomenclature
The coupon rate and year of maturity identifies the government security.
Example: 12.25% GOI 2008 indicates the following:
12.25% is the coupon rate, GOI denotes Government of India, which is the borrower, 2008 is the year of maturity.

Eligibility
All entities registered in India like banks, financial institutions, Primary Dealers, firms, companies, corporate bodies, partnership firms, institutions, mutual funds, Foreign Institutional Investors, State Governments, Provident Funds, trusts, research organisations, Nepal Rashtra bank and even individuals are eligible to purchase Government Securities.

Availability
Government securities are highly liquid instruments available both in the primary and secondary market. They can be purchased from Primary Dealers. PNB Gilts Ltd., is a leading Primary Dealer in the government securities market, and is actively involved in the trading of government securities.

Forms of Issuance of Government Securities

Banks, Primary Dealers and Financial Institutions have been allowed to hold these securities with the Public Debt Office of Reserve Bank of India in dematerialized form in accounts known as Subsidiary General Ledger (SGL) Accounts.

Entities having a Gilt Account with Banks or Primary Dealers can hold these securities with them in dematerialized form.

In addition government securities can also be held in dematerialized form in demat accounts maintained with the Depository Participants of NSDL.

Minimum Amount

In terms of RBI regulations, government dated securities can be purchased for a minimum amount of Rs. 10,000/-only.Treasury bills can be purchased for a minimum amount of Rs 25000/- only and in multiples thereof. State Government Securities can be purchased for a minimum amount of Rs 1,000/- only.

Repayment

Government securities are repaid at par on the expiry of their tenor. The different repayment methods are as follows :

For SGL account holders, the maturity proceeds would be credited to their current accounts with the Reserve Bank of India.

For Gilt Account Holders, the Bank/Primary Dealers, would receive the maturity proceeds and they would pay the Gilt Account Holders.

For entities having a demat acount with NSDL,the maturity proceeds would be collected by their DP's and they in turn would pay the demat Account Holders.

Day Count

For government dated securities and state government securities the day count is taken as 360 days for a year and 30 days for every completed month. However for Treasury bills it is 365 days for a year.

Example : A client purchases 7.40% GOI 2012 for face value of Rs. 10 lacs.@ Rs.101.80, i.e. the client pays Rs.101.80 for every unit of government security having a face value of Rs. 100/-  The settlement is due on October 3, 2002. What is the amount to be paid by the client?

The security is 7.40% GOI 2012 for which the interest payment dates are 3rd May, and 3 rd November every year.

The last interest payment date for the current year is 3 rd May 2002. The calculation would be made as follows:

Face value of Rs. 10 lacs.@ Rs.101.80%.

Therefore the principal amount payable is Rs.10 lacs X 101.80% =10,18,000

Last interest payment date was May 3, 2002 and settlement date is October 3, 2002. Therefore the interest has to be paid for 150 days (including 3 rd May, and excluding October 3, 2002)

(28 days of May, including 3 rd May, up to 30 th May + 30 days of June, July, August and September + 2 days of October). Since the settlement is on October 3, 2002, that date is excluded.

Interest payable = 10 lacs X 7.40% X 150 = Rs. 30833.33.

360 X 100

Total amount payable by client =10,18,000+30833.33=Rs. 10,48,833.33

Benefits of Investing in Government Securities

No tax deducted at source

Additional Income Tax benefit u/s 80L of the Income Tax Act for Individuals

Qualifies for SLR purpose

Zero default risk being sovereign paper

Highly liquid.

Transparency in transactions and simplified settlement procedures through CSGL/NSDL.

Methods of Issuance of Government Securities

Government securities are issued by various methods, which are as follows:

Auctions:
Auctions for government securities are either yield based or price based.

In an yield based auction, the Reserve Bank of India announces the issue size(or notified amount) and the tenor of the paper to be auctioned. The bidders submit bids in terms of the yield at which they are ready to buy the security.

In a price based auction, the Reserve Bank of India announces the issue size(or notified amount), the tenor of the paper to be auctioned, as well as the coupon rate. The bidders submit bids in terms of the price. This method of auction is normally used in case of reissue of existing government securities.

The basic features of the auctions are given below:

Method of auction: There are two methods of auction which are followed-

Uniform price Based or Dutch Auction procedure is used in auctions of dated government securities. The bids are accepted at the same prices as decided in the cut off.

Multiple/variable Price Based or French Auction procedure is used in auctions of Government dated securities and treasury bills. Bids are accepted at different prices / yields quoted in the individual bids.

Bids: Bids are to be submitted in terms of yields to maturity/prices as announced at the time of auction.

Cut off yield: is the rate at which bids are accepted. Bids at yields higher than the cut-off yield is rejected and those lower than the cut-off are accepted. The cut-off yield is set as the coupon rate for the security. Bidders who have bid at lower than the cut-off yield pay a premium on the security, since the auction is a multiple price auction.

Cut off price: It is the minimum price accepted for the security. Bids at prices lower than the cut-off are rejected and at higher than the cut-off are accepted. Coupon rate for the security remains unchanged. Bidders who have bid at higher than the cut-off price pay a premium on the security, thereby getting a lower yield. Price based auctions lead to finer price discovery than yield based auctions.

Notified amount: The amount of security to be issued is ‘notified' prior to the auction date, for information of the public. The Reserve Bank of India (RBI) may participate as a non-competitor in the auctions. The unsubscribed portion devolves on RBI or on the Primary Dealers if the auction has been underwritten by PDs. The devolvement is at the cut-off price/yield.

Underwriting in Auctions

For the purpose of auctions, bids are invited from the Primary Dealers one day before the auction wherein they indicate the amount to be underwritten by them and the underwriting fee expected by them.

The auction committee of Reserve Bank of India examines the bids and based on the market conditions, takes a decision in respect of the amount to be underwritten and the fee to be paid to the underwriters.

Underwriting fee is paid at the rates bid by PDs , for the underwriting which has been accepted.

In case of the auction being fully subscribed, the underwriters do not have to subscribe to the issue necessarily unless they have bid for it.

If there is a devolvement, the successful bids put in by the Primary Dealers are set-off against the amount underwritten by them while deciding the amount of devolvement.

On-tap issue

This is a reissue of existing Government securities having pre-determined yields/prices by Reserve Bank of India. After the initial primary auction of a security, the issue remains open to further subscription by the investors as and when considered appropriate by RBI. The period for which the issue is kept open may be time specific or volume specific. The coupon rate, the interest dates and the date of maturity remain the same as determined in the initial primary auction. Reserve Bank of India may sell government securities through on tap issue at lower or higher prices than the prevailing market prices. Such an action on the part of the Reserve Bank of India leads to a realignment of the market prices of government securities. Tap stock provides an opportunity to unsuccessful bidders in auctions to acquire the security at the market determined rate.

Fixed coupon issue

Government Securities may also be issued for a notified amount at a fixed coupon. Most State Development Loans or State Government Securities are issued on this basis.

Private Placement

The Central Government may also privately place government securities with Reserve Bank of India. This is usually done when the Ways and Means Advance (WMA) is near the sanctioned limit and the market conditions are not conducive to an issue. The issue is priced at market related yields. Reserve Bank of India may later offload these securities to the market through Open Market Operations (OMO).

After having auctioned a loan whereby the coupon rate has been arrived at and if still the government feels the need for funds for similar tenure, it may privately place an amount with the Reserve Bank of India. RBI in turn may decide upon further selling of the security so purchased under the Open Market Operations window albeit at a different yield.

Open Market Operations (OMO)

Government securities that are privately placed with the Reserve Bank of India are sold in the market through open market operations of the Reserve Bank of India. The yield at which these securities are sold may differ from the yield at which they were privately placed with Reserve Bank of India. Open market operations are used by the Reserve Bank of India to infuse or suck liquidity from the system. Whenever the Reserve Bank of India wishes to infuse the liquidity in the system, it purchases government securities from the market, and whenever it wishes to suck out the liquidity from the system, it sells government securities in the market.

State Government Securities

State Government Securities are securities/loans issued by the Reserve Bank of India on behalf of various state governments for financing their developmental needs. These securities are auctioned by the Reserve Bank of India from time to time. These auctions are of fixed coupon, with pre announced notified amounts for different states.

Approved Securities

Approved securities are the securities, which are eligible for SLR purposes under Section 24 of the Banking Regulation Act.