Until recently, these bonds were exclusively accessible at select branches of the State Bank of India, nationalised banks, private sector banks authorised by the RBI, and other entities designated by the Reserve Bank of India, following the government’s guidelines on floating rate bonds released in June 2020. According to an RBI circular dated October 23, 2023, retail investors can now access a more diverse spectrum of investment instruments through the Retail Direct Portal.
What are floating rate bonds?
FRSBs are interest-bearing bonds issued by the central government. They are non-tradeable and mature after seven years from the date of issue. Interest on these bonds is paid semi-annually on January 1 and July 1 each year, with no provision for cumulative interest payments.
Generally, bonds come with a fixed coupon or interest rate. For example, you can buy a bond of Rs 10,000 with a coupon rate of 5%. In the case of such a bond, you will be paid an annual interest amount of Rs 500 by the bond issuer. This interest is constant and does not fluctuate based on the current interest rate of the market.
However, a floating rate bond is a debt instrument that does not have a fixed coupon rate, but its interest rate fluctuates based on the benchmark the bond is drawn. Benchmarks are market instruments that influence the overall economy. For example, repo rate or reverse repo rate can be set as benchmarks for a floating rate bond.
The interest rate on RBI Floating Rate Bonds is linked to the prevailing market interest rates, specifically, the National Saving Certificate (NSC) rates, with a spread of 35 basis points. The current interest rate on the RBI Floating Rate Bonds is 8.05%, subject to revisions every six months. The interest received on these bonds is taxable at a slab rate, similar to any bank FD.
The interest rate on these bonds is reset every six months and is due on January 1, 2024, next. Compared to fixed deposits, the interest rate on these floating-rate bonds is higher but the bond rates could be revised downwards in the next review cycle if inflation remains under control.
” Such bonds are suitable for conservative investors seeking assured returns from a lump-sum investment. Not suitable for investors who can assume some risk by investing in equity-linked investments, which can generate much higher returns. Alternatives can be (i) Balanced mutual funds (for those who can assume risk), (ii) Bank fixed deposits, though the rate of return is lower, and (iii) Company deposits,” said Value Research in anote.
Your capital in floating-rate bonds is fully protected. However, there is no inflation protection, which means whenever inflation is above the latest interest rate, the deposit earns no real returns. However, when the inflation is below the current interest rate, it does manage a positive real rate of return.
Moreover, these bonds are not listed and traded and you cannot take loans against them. “You are effectively locked in for a tenure of seven years. However, pre-mature encashment is allowed with a penalty for senior citizens after a minimum lock-in period, which varies from four to six years depending on the age bracket in which the senior citizen falls,” noted Value Research.
Pros and Cons as per BankBazaar
The pros are that this is a sovereign bond so you get 100% assured returns and capital safety. There’s liquidity twice a year through interest payouts. And if you’re in a low-interest environment, this instrument assures automatically higher returns as and when rates go up. Essentially, it’s like a floating rate fixed deposit which some large banks offer. The cons are that it’s not a liquid instrument due to a seven-year lock-in, though senior citizens can liquidate the bond in 4-6 years. It’s not tradeable as well like many bonds are. Secondly, we’re in a high-rate scenario where rates are not likely to rise too much and are poised to fall. Also, the returns are fully taxable.
What should investors do?
“If you’re an investor under 60, you may get similar returns from a regular bank FD though only smaller banks will currently go over 8%. But even if you’re offered 7.5%, you can lock into that for 5-10 years. If you’re above 60, you can avail the Senior Citizens Savings Scheme offering a floating rate of 8.2% over 5 years, with the option of extending the investment in blocks of 3 years. If you’re the parent of a girl child, you can earn tax-free returns of 8% from Sukanya Samriddhi but it’s a much longer investment,” said Adhil Shetty, CEO of Bankbazaar.