The Reserve Bank of India’s (RBI) new scheme to attract direct retail investments in government securities, till now an institutional investors’ forte, may not work without tax benefits.
On Nov. 12 (Friday), prime minister Narendra Modi announced a scheme called RBI Retail Direct, providing a direct portal and improving ease of access for retail investment in government bonds. Until now, individual investors could buy a minimum lot of sovereign debt worth 10,000 rupees (nearly $135) only through the non-competitive segment of primary auctions held every Friday.
A non-competitive tender is an offer by non-institutional investors to purchase government bonds. They do not participate in formal auctions and buy at the market price set by other participants.
“If retail taxation of direct debt investments is brought in line with investing through debt funds, we should see some retail interest emerging,” Ananth Narayan, associate professor at SP Jain Institute of Management and Research, told the Economic Times.
Why the push for Indian government bonds?
The government uses funds raised from bond-sale, where an investor lends money to the state, to spend on public services. Usually, the annual borrowing programme is announced in the Union Budget as revenue falls short of spending.
In the past few years, borrowing has ballooned on account of the government’s push for economic growth, the covid-19 vaccination plan, and rising commodity prices. In the financial year 2021-22, the government is expected to borrow a massive Rs12.06 lakh crore through government bonds alone, compared to the Rs7.8 lakh crore in the previous year.
The government’s backing makes these instruments highly secure and low-risk. Yet, the investor pool has remained stagnant.
Why the scheme may not woo retail investors?
To begin with, most retail investors are unfamiliar with bonds. Marzban Irani, chief investment officer—fixed income of LIC Mutual Fund, believes that retail investors should be educated.
Secondly, even though the new RBI platform for bonds has clocked over 20,000 registrations since its launch on Nov. 12, the investment process seemed cumbersome for small investors.
A standard lot size to trade government bonds is Rs5 crore. However, smaller players like cooperative banks or retail investors may not be able to transact in that lot size. The RBI has, thus, now allowed retail investments in the “Odd Lot” segment (pdf)—that are not multiples of Rs5 crore.
This, however, also means that volumes in the segment may not be meaningful, according to Amit Shewale, a Mumbai-based fixed income trader.
There is, then, little incentive for smaller investors—despite government debt being risk-free—since they have a plethora of alternatives with better returns and tax exemptions. ”…currently, small savings schemes offer much higher rates than GoI securities (government securities),” said Narayan.
For instance, the yield on the 10-year benchmark bond today is at 6.35%, resulting in a post-tax return of 4.45% for an individual in the highest tax bracket. In comparison, a five-year small-savings deposit earns a return of 6.7%, with tax benefits.
So far, investors have had an option to buy sovereign debt through debt mutual funds, which also offer indexation benefits, minimising the tax payable on returns on investments.