What are Government Bonds?

Government bonds are securities issued by central or state governments to raise funds for public expenditure. An investor who purchases government bonds essentially lends money to the government in return for periodic interest payments, known as coupons, and the principal amount at maturity. As these securities are backed by the government, they are mostly considered safer than many other fixed-income investments. In this article, we will see how Government bonds work, their types, characteristics, and more. 

How Do Government Bonds Work? 

Here's a step-by-step explanation of how investing in government bonds work:
Step 1: Issuance 

The issue of bonds is announced through the RBI. Bonds are issued through primary auctions, wherein investors can place their bids to buy the bond issues. 

Step 2: Investment 

Depending on the type, investors buy bonds either at their face value or at a discount. The purchase is a type of loan to the government. 

Step 3: Coupon Payments 

The government pays interest at periodic intervals. Most bonds in India are with fixed interest rates, paid semiannually or annually. 

Step 4: Market Trading 

Government bonds are tradable in the secondary market prior to their maturity dates. That means an investor can sell or buy bonds on the stock exchanges, hence providing liquidity to their investment. 

Step 5: Repayment at Maturity 

The government returns the principal amount to the investor when the bond has reached its maturity date; hence, completing the cycle of investment. 

Key Characteristics of Government Bonds 

The following points explain the main features that government bonds in India generally offer: 

• Fixed Maturity: Each bond has a set maturity date on which the government returns the principal amount to the investor. 
• Common Interest Payments: Investing in government bonds provides periodic interest payments (monthly, quarterly, semi-annually, and yearly). 
• Government Backing: Government of India bonds are backed by the government and thus are considered more stable, with a reduced risk of default. 
• Tradable on the Secondary Market: Government bonds can be bought or sold in the secondary market prior to maturity, providing an effective means of liquidating one's investment, if necessary. 
• Fixed or Variable Interest Rates: Government bonds may offer fixed or variable interest rates based on the prevailing benchmark interest rate. 
• Long-Term Maturity Dates: Government bonds generally have longer maturity dates; most fall between 5 and 40 years in length, allowing for effective management of income and capital. 

Types of Government Bonds in India 

Below is a list of government bond types in India:

Dated Government Securities (G-Secs)

These are long-term bonds issued by the central government with maturities ranging from 1 to 50 years. They carry fixed or floating interest rates and represent the most common type of government bond. The interest earned is taxable according to the investor's income tax slab. 

Treasury Bills (T-Bills)

These are short-term instruments with maturities of 91, 182, or 364 days. T-Bills are zero-coupon securities issued at a discount to face value and redeemed at par. The difference between the purchase price and face value represents the investor's return. 

State Development Loans (SDLs)

Bonds issued by state governments to finance their development projects and fiscal requirements. These carry similar characteristics to central government securities but are backed by state government guarantees rather than the central government. 

Floating Rate Bonds (FRBs)

These are the type of bonds whose interest rate is periodically reset based on a benchmark rate. Commonly, these will have some sort of base rate plus a fixed spread; the spread does not change, but the base rate will be altered over time in line with market conditions. 

Inflation-Indexed Bonds

These bonds protect investors against inflation by linking the principal or interest to inflation indices like the Consumer Price Index (CPI) or Wholesale Price Index (WPI). This structure allows the bond value or payouts to adjust in line with inflation trends rather than remain fixed. 

Sovereign Gold Bonds (SGBs)

Sovereign gold bonds are unique instruments denominated in grams of gold that offer exposure to gold prices without physical possession. They provide an additional 2.5% annual interest rate and have an eight-year maturity, with early redemption allowed after five years. 

Tax-Free Bonds

Government entities and public sector undertakings issue these bonds, which offer tax-exempt interest income. This makes them suitable for investors in higher tax brackets. 

7.75% GOI Savings Bonds

7.75% GOI Savings Bonds were retail-oriented instruments offered by the government, carrying a fixed 7.75% interest rate and a seven-year maturity. These bonds were discontinued for new investments in 2020, but they still help illustrate how fixed-rate government savings instruments work. 

How to Buy Government Bonds? 

Investing in government bonds in India can be done through several channels: 

Method 1: RBI Retail Direct Platform 

Step 1: Visit the official site at rbiretaildirect.org.in and select the option "Open RBI Retail Direct Account" to get started. 

Step 2: Enter personal details in the application form such as name (as it appears on PAN), email id, mobile number associated with Aadhaar, PAN number, date of birth, and bank account information. 

Step 3: The digital KYC process, which consists of Aadhaar-based verification and video identification, should be completed within 3 days from the date of registration. 

Step 4: The necessary documents, like PAN card, image of signature, and verifying bank account (through online verification or a cancelled cheque), are to be uploaded. 

Step 5: After account gets activated, which normally takes one business day, individuals can check the government securities that are currently available. 

Step 6: Investors can select the bonds they want to purchase, and then either place an order through non-competitive bidding in a primary auction or buy existing bonds in the secondary market. 

Step 7: Make the transaction using either UPI or net banking from bank account that is linked to Retail Direct account. 

Step 8: The bonds will be transferred into the RBI Retail Direct Gilt (RDG) account, and during this process, the investor will have the ability to monitor their investments online. 

Method 2: Through Stock Brokers 

Just open a Demat account and a trading account with a SEBI-registered broker who allows investing in government bonds. Individuals can purchase bonds through either the NSE goBID platform or their broker's trading platform. 

Method 3: Through Banks 

Some banks allow investors to invest in government bonds. Investors can visit any of their branches or use online portal. Most government bonds have a minimum investment of Rs. 10,000, while for Sovereign Gold Bonds, it is Re. 1 per gram. 

Knowing what are government bonds and how to buy government bonds in India is crucial, let’s see what factors affect its prices further in the article. 

What Affects Government Bond Prices? 

Government bond prices and yields change based on several market factors: 

1. Interest Rates: Bond prices and interest rates move in opposite directions. When government bonds interest rates go up, bond prices tend to fall. When rates go down, bond prices generally rise. 
2. Inflation: Inflation affects the real value of bond payments. When people expect inflation to increase, bond prices often decline as investors look for higher returns to compensate. 
3. Government Borrowing: The amount of borrowing matters. When governments issue more bonds, the increased supply can put downward pressure on prices. When government finances are strong, bond prices usually stay supported. 
4. Market Demand: Demand from various buyers influences prices. This includes institutional investors, banks, and foreign buyers. How easily bonds can be bought and sold also affects their pricing. 

Who Should Invest in Government Bonds? 

Government bonds tend to suit investors looking for safety and a low level of risk. Fixed-income earners like retired people and senior citizens may find them suitable as they give a fixed return on interest. Long-term savers may find these bonds suitable, as they allow the allocation of debt to varying tenures. Those who prefer to avoid equity market ups and downs may find government bonds more stable. Due to their low correlation with stocks, these bonds may also help in the diversification of the portfolio. However, the final investment decision should be based on the investor’s investment goals and risk appetite 

Advantages and Disadvantages of Government Bonds 

The table below provides a simple comparison to help understand how government bonds fit into an investment portfolio. 

Conclusion 

Investors may use government bonds as a secure and reasonably low-risk way to get stable and predictable returns over a long time for long-term financial stability. Understanding how they operate, what kinds are available, and other risk factors can assist an investor in determining what is suitable for their investment strategy. Additionally, investors can explore a stock market trading app that allows them easy access to purchase and trade equities and bonds.