A guaranteed returns option to tackle low interest rates

The Monetary Policy Committee (MPC) in its latest meeting has sent out mixed signals about the future direction of interest rates. Citing an uncertain inflation outlook, it called a pause to its repo rate cuts, holding the rate at 4 per cent. At the same time, it also promised to continue its ‘accommodative stance’ due to unprecedented Covid stress on the economy.  

This confusing stance presents a dilemma for fixed income investors who are already earning rock-bottom returns on their fixed deposits and bonds.

If they lock into current rates for 1 or 2-year terms fearing further rate cuts, any revival in the interest rate cycle will result in an opportunity loss. But if they delay the decision by idling their money in a savings account, that leads to loss of returns too. Floating rate instruments that offer guaranteed returns are good solution to this dilemma.

Why floating?

PrimeInvestor’s view on rates is that even if the MPC cuts rates by 25-50 basis points, at most, from here if inflation softens, the downside to market interest rates from current levels may be quite limited. Interest rates are already at a two-decade low and the past two rate cycles have seen the repo rate range between a low of 4.75% and a high of 8 %.

A year or two from now, as the economy normalises after Covid and inflation rears its head, it is quite likely that India’s interest rates too will rise from the abnormal lows triggered by Covid. Yes, this process can take some time and rates may remain rangebound or volatile for the next six months to a year before they rise.  

We believe that this situation is opportune for investors to buy floating rate bonds. With floating rate bonds, investors may see muted returns in the next six months or so but will get to participate in any revival in rates thereafter without having to switch instruments.

The Floating Rate Savings Bonds 2020 (Taxable) issued by the Government of India, are an excellent bet for investors seeking guaranteed returns and regular income with unimpeachable safety.

In an earlier article, PrimeInvestor had highlighted that GOI’s 7.75% taxable bonds offered an unusual island of high returns in a falling rate environment https://www.primeinvestor.in/can-you-get-high-returns-with-a-government-guarantee-you-can-with-this-debt-instrument/

Not surprisingly, these bonds were discontinued in end May 2020. Fortunately, however, the government has been quick to launch a substitute in the form of the Floating Rate Savings Bonds (FRSBs) 2020. While the rates offered are not as high as earlier, the floating nature of returns does allow you to benefit from any future rise in rates.

The new FRSBs carry a 7-year lock in period. They will be available on tap until RBI notifies otherwise. FRSBs only offer a regular payout option and no cumulative option. They will pay half yearly interest on 1^st July and 1^st January each year at a rate that the government notifies. This rate is pegged to the interest rate offered on the National Savings Certificates, at a 35 basis point spread over the latter. The interest rate will be reset every six months. The current interest rate, payable in January 2021, is 7.15%. 

The interest on the bond is taxable at the investor’s slab rate, same as FDs and other fixed income instruments. 

Why buy?

So why do we think FRSBs are a good option, indeed one of the best regular income avenues, for investors today?

#1 Sovereign guarantee: Being GOI borrowings backed by sovereign guarantee these are among the safest fixed income avenues in the market, ranking even higher in safety than bank deposits. Yet, the interest rate FRSBs offer today is much higher than that from leading bank and even NBFC fixed deposits. Currently, SBI and HDFC Bank offer just 5.1-5.2% for 1 to 3 year FDs and 5.5-5.7% 5-year plus FDs. This GOI bond offers a good 145 basis point spread over these FDs despite being a Central government guaranteed instrument.

#2 No limits: Post office schemes that offer regular income such as Senior Citizens Savings Scheme and National Savings Monthly Income Account (earlier POMIS) specify maximum limits on how much an individual can invest (Rs 15 lakh for SCSS and Rs 4.5 lakh for POMIS). This restricts the amount of income you can earn from these instruments. For the FRSBs though, there’s no such ceiling and you can freely use it for your debt allocations. Plus with the SCSS or POMIS you’ll be locking into current low rates for a 5 year tenure, while with FRSBs your rates will float up automatically if market rates rise.

#3 Guaranteed spread over g-sec: The government has promised to set the interest rate on FRSBs at a 35 basis point spread over the five-year NSC (National Savings Certificates). Officially, the interest rate on the NSC itself is supposed to be at a 25 basis point spread over the 5-year government security. In practise, if you look back at history, the government has usually set interest rates on the NSC at a far higher spread over comparable g-secs.

The table below, which captures the past interest rates on the NSC at half yearly intervals tells us that the  interest rate on the NSC has usually been set at a spread of anywhere between 30 basis points and 170 basis points over the 5 year g-sec rate.

Given that FRSBs will be delivering 35 basis points more than the NSC rate, you can therefore look forward to earning a minimum spread of 60 basis points over the 5 year g-sec on this bond while the maximum (if the government is feeling charitable) may go upto 200 basis points!

Given that FRSBs are offering 7.15% during the abnormally low rate scenario of today, there’s every possibility that the rates will float up with the NSC and g-sec rates over the next year or two.

How to apply for this guaranteed returns product

Just like their predecessor, the Floating Rate Savings Bonds (FRSBs) 2020 are sold through SBI, 11 nationalized banks and 4 private sector banks authorized by RBI. The list of entities who can sell you these bonds is available here https://rbidocs.rbi.org.in/rdocs/content/pdfs/30062020Appendix_1.pdf

To apply, you may need to request a physical form or download an online one from the above-mentioned banks and hand over the filled application to the authorised representative. The bank in turn will credit the bonds to a Bond Ledger Account held in your name and issue you a Certificate of Holding with distinct numbers within 7 days. Your later purchases can be added to this account. This certificate can be sent to your email ID as well.

 Do note that while this bond is held in electronic form, it will not figure in your demat account as the Bond Ledger Account maintained by RBI is distinct from the demat account held with your depository.

Do note that because these bonds compete directly with their FD products and offer higher rates, bank RMs are usually not too keen to push them. You may therefore have to specifically ask for these bonds and nag your bank RM a bit to be able to invest in them. Use this RBI notification https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11924&Mode=0.

Who should buy

• Retirees seeking regular income
• Debt investors willing to take higher lock ins for better returns than bank FDs
• VRS optees who aren’t eligible for the SCSS due to age
• Investors seeking a safe option for their debt allocation