Suitable for those who need regular income; the interest rate on these 7-year taxable bonds will be reset every six months
For those who lamented the government’s decision to stop selling 7.75% bonds, there is a welcome news. The government has announced the launch of Floating Rate Savings Bonds 2020, which will replace the erstwhile RBI taxable 7.75% bonds. The bonds are expected to be available for subscription from 1st July.
The new 2020 bonds carry effectively zero credit risk because of sovereign backing and have no maximum investment limit besides being attractive with the starting 7.15% interest rate. Although the return is taxable, the bonds offer little extra liquidity before 7-year maturity.
Being a floating rate bond with interest reset every 6 months, rates could drop more before they rise in step with the struggling economy. Of course, for those who need regular income like senior citizens, the floating rate bonds offer a higher return than many competing guaranteed return products, besides offering some sort of inflation-protection.
A floating-rate bond offers an interest rate that is liable to change. This is a major difference compared to fixed-rate bonds or fixed deposits where you basically know what you will be getting. Hence, long-term planning can be done if you use a buy and hold strategy.
When the interest rates increase in the economy, the interest rate increases. If interest rates drop, the return on floating-rate bonds drop. In some sense, floating-rate bonds are not immune to interest rate risk, though at a lower degree than more tax-efficient debt mutual funds which give no minimum return guarantee. A part of the NAV (net asset value) of debt funds move as per the interest-rate trajectory.
The soon-to-be-launched Floating Rate Savings Bonds 2020 has an initial interest rate of 7.15%. The Interest rate for the next half-year will be reset every six months. So, expect the first reset, if at all, in January 2021. For those asking how the 7.15% has been determined, you see the Floating Rate Savings Bonds 2020 will always offer 35 basis points (1 basis point is 0.01%) more than the prevailing National Saving Certificate (NSC) rate. At this moment, NSC is giving 6.8% interest for the first quarter (April to June). There is a quarterly revision of interest rates for small-saving schemes like NSC.
The floating rate bonds have a maturity tenure of 7 years from the date of issue. This is longer than Post Office MIS (Monthly Income Scheme account), Senior Citizens Savings Scheme (SCSS), NSC. Of course, premature redemption will be allowed for specified categories of senior citizens; this is in line with the now-closed sale of GoI bonds (that offered 7.75%)
The new bonds can be held individually or jointly by resident Indians. They can also be held on behalf of a minor as a father/mother/legal guardian. Importantly, NRIs cannot invest just like NRIs could not invest in those GoI bonds that offered 7.75%.
One major difference between 7.75% GoI bonds and thew Floating-Rate Savings Bonds 2020 is that there is no cumulative option in the latter. The interest on the new bonds is payable semi-annually on January 1 and July 1 every year. The cumulative facility meant that one could invest a lump sum and get a lump sum on maturity. We believe the government wants to promote the floating-rate bonds as a regular ‘income’ option so it has paused the cumulative facility.
The bonds will be issued at par at Rs 100 for a minimum amount of Rs 1,000 (nominal value) and in multiples thereof. The bonds, in the form of Bonds Ledger Account (BLA), will be opened (issued) from the date of tender of cash (up to Rs 20,000 only), or date of realisation of cheque/draft/funds.
Applications for bond purchase will be received at the branches of SBI, Nationalised banks and specified private sector banks, either directly or through their agents.
These bonds are not tradeable, so there is no extra liquidity path for those who want to sell this at an exchange platform or to an interested buyer. For example, the Sovereign Gold Bonds (SGBs) are tradeable on a stock exchange which adds on to the liquidity feature. Do keep one thing in mind. The floating-rate savings bonds 2020 are better than tax-free bonds available in the secondary market because the latter trades at prices which is at a significant premium.
Also, do note that the interest from Floating-Rate Savings Bonds 2020 is taxable as per your applicable slab. The interest from 7.75% GoI bonds were also taxable. There are very few tax-free options in the financial market. Post office deposits, bank deposits, recurring deposits, Post Office MIS, NSC, Kisan Vikas Patra (KVP). There exist only two popular guaranteed return investment avenues that are tax-free: PPF and Sukanya Samriddhi Yojana (SSY). But PPF has a minimum tenure of 15 years and has an investment restriction of Rs 1.5 lakh annually. SSY also has a maximum investment cap and the maximum tenure is 21 years.
The floating-rate savings bonds 2020 are in many ways ideal for those who need income. You cannot lock the money, unlike what you can do in bank deposits with cumulative option or insurance endowment plans.
By making the bonds ‘floating’, the government has made this a safe guaranteed return product but the income is not regular in nature. If interest rates fall from here on, the 6-month reset will reflect that. Of course, if interest rates in the economy rise, then the floating-rate bonds will give more.
One of the main reasons investors require liquidity from an investment is the peace of mind that at any point you can withdraw the money. The floating-rate bonds will not give you that. But, given that this is a sovereign backed investment avenue, the usual worry of the issuer going away or defaulting does not arise. If you have other sources of liquidity like emergency corpus and bank deposits, then the new bonds are a good bet. This is because the 35 basis point premium over NSC will mean you will always get higher interest than at least NSC.
The bonds cannot be used as collateral for loans. But, they can be inherited by the legal heirs of the holder. This is a good thing since succession planning is available.
The new bonds give a somewhat inflation shield to bondholders. Inflation is a major problem with any investment as it eats away the returns. The floating-rate bonds, as a construct, move up or down with interest rates, which are indirectly linked to how inflation moves. If inflation rises, the interest rate is hiked. When inflation falls, the interest rate is lowered. So when inflation rises, the floating-rate bonds will get a higher return. Most of the available guaranteed return products do not offer any opportunity to earn more if interest rates in the economy rise. Annuity products from life insurance companies offer long-term regular income, but they offer quite low returns.
For senior citizens, the new bonds are another option to diversify their investment basket. They already have Pradhan Mantri Vaya Vandana Yojana (PMVVY) and Senior Citizens Savings Scheme. But both of these options have a maximum limit of Rs 15 lakh per person. If you have more money with you that you want to use for getting a regular income, these bonds will be handy.
Debt mutual fund returns are an option always due to higher tax-efficiency if you sell after more than three years and provide daily liquidity (exit option), but they can neither guarantee returns nor they carry sovereign backing. Also, it is difficult to accurately estimate the potential returns from debt funds. The new floating-rate bonds tell you beforehand what the interest rate is going to be, giving you time to plan things in case rates decline.
You can read the government information document here.
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