Government securities

Also called: G-secs · Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

A government security (G-sec) is a tradable debt paper that the Central Government or a state government sells to borrow money. The buyer lends money to the government. In return, the government promises to pay interest and to repay the money on a fixed date. G-secs carry practically no default risk, so they are called "gilt-edged" or risk-free assets. Most government borrowing in India is done through them. They also sit at the centre of how the RBI manages money in the economy and how interest rates are set.

Current yield = (annual coupon ÷ market price) × 100

Explanation

What a G-sec is and why it is "risk-free"

• Debt paper: buying a G-sec means lending money to the government.
• Tradable: the holder can sell it to someone else before it matures (reaches its repayment date).
• Issuer: the Centre or the states.
• Practically no default risk: the government can raise taxes or create money to repay. So the chance of non-payment is close to zero.

Types, by length of the loan

• Short-term (less than one year):
• Treasury Bills (T-bills) and Cash Management Bills (CMBs).

• Only the Central Government issues these.

• Long-term: dated securities

• The RBI defines these as securities with an original maturity of one year or more [5].
• Maturity usually runs from about 2 to 50 years. India issued its first 50-year bond in 2022.

• State governments issue only dated securities, called State Development Loans (SDLs) [5].

• Special G-secs:

• Inflation-indexed bonds (IIBs): the principal or the coupon rises with inflation. This protects the investor's real return (the return left after inflation).
• Oil bonds (2005-10): non-cash securities given to oil marketing companies instead of cash subsidy.
• Sovereign Gold Bonds (SGBs, November 2015): G-secs denominated in grams of gold.

How a dated security works: coupon, price and yield

• Coupon: the fixed interest rate a bond pays. It is worked out on the bond's face value (the amount printed on the bond, usually ₹100).
• The coupon can be fixed or floating. A floating coupon is reset from time to time according to a benchmark rate.
• It is paid half-yearly.

• Example: a ₹100 bond with a 7% coupon pays ₹7 a year, as ₹3.50 every six months.

• Yield: the actual return a buyer earns, given the price they pay.

• Bond price and yield move in opposite directions:
• Market interest rates rise → new bonds pay more → the old 7% bond becomes less attractive.
• Its price falls to ₹95.
• Current yield = 7 ÷ 95 × 100 = 7.37%.

• So when the price falls, the yield rises. When the price rises, the yield falls.

• Why this matters for banks:

• The RBI raises rates → bond prices fall → banks holding many bonds see their value drop.
• This is called a mark-to-market loss (a loss that comes from valuing assets at today's market price).

How G-secs are sold and traded

• Primary market: the government sells new bonds through auctions run by the RBI.
• Secondary market: investors trade existing bonds among themselves.

• NDS-OM (Negotiated Dealing System – Order Matching) is the RBI's electronic, anonymous screen for this trading.

• Non-competitive bidding:

• Small investors bid only for an amount, not a price.
• They get bonds at the average price that comes out of the auction.

• The RBI introduced this to bring small investors into primary auctions [5].

• Primary dealers (PDs): entities authorised by the RBI that:

• underwrite auctions, which means they promise to buy any part of an auction that other bidders do not take up;
• make markets, which means they always quote a buy price and a sell price so that others can trade easily.

In India

• Law: the Government Securities Act 2006 governs how G-secs are issued, transferred and held.
• Debt manager:
• The RBI manages the Centre's debt by statute, under the RBI Act 1934.

• It manages the states' debt by agreement with each state.

• States:

• Under Article 293, a state needs the Centre's consent to borrow if it still owes money to the Centre.
• SDLs trade at a spread (extra yield that investors ask for) over central G-secs of the same maturity.

• Example: a 10-year G-sec yields 6.8% and a 10-year SDL yields 7.2%. The spread is 40 basis points (1 basis point = 0.01%). Investors see state finances as slightly riskier and SDLs as harder to sell quickly.

• Primary dealers:

• Introduced in 1995-96.
• They come in two forms: standalone PDs (separate companies) and bank-PDs (banks that run PD business as a department).
• They may underwrite dated securities of both the Government of India and state governments [6].

• Their turnover ratio (how much a PD trades in a year compared with what it holds) in outright deals must be at least 3 times in dated G-secs and 6 times in T-bills/CMBs [6].

• RBI Retail Direct (November 2021):

• Individuals open a Retail Direct Gilt (RDG) account with the RBI through an online portal [3].
• They can buy in primary auctions through non-competitive bids. They can also buy and sell on NDS-OM in the "Odd Lot" and "Request for Quote" segments [3].

• A mobile app (May 2024) and an auto-bidding facility for T-bills were added later [4].

• SLR and OMOs:

• SLR (Statutory Liquidity Ratio): banks must keep a set share of their deposits in liquid assets, mostly G-secs. This makes them captive buyers, meaning they buy G-secs because the rules require it, not by choice.

• OMOs (Open Market Operations):

  • The RBI buys G-secs → it pays out money → liquidity rises.
  • The RBI sells G-secs → it takes money back → liquidity falls.

• Sovereign Gold Bond:

• 2.5% interest a year on the issue value. Example: an issue price of ₹5,000 per gram gives ₹125 a year per gram.
• 8-year tenure. Early exit is allowed after the 5th year, on a date when interest is due [2].
• The redemption price is the simple average of the closing price of 999-purity gold over the previous 3 business days, as published by the IBJA [2]. For example, it was ₹7,231 per unit for redemption due on 30 April 2024 [2].
• Capital gains on redemption are tax-free.

• No fresh tranche has been issued since February 2024, because rising gold prices made repayment costly for the government.

• Foreign access:

• The general limits for FPI (foreign portfolio investor, meaning a foreigner who buys bonds or shares without taking control of a company) are 6% of outstanding central G-secs and 2% of outstanding SDLs [1].
• The Fully Accessible Route (FAR), introduced by an RBI circular of 30 March 2020, allows non-residents to invest in specified G-secs with no investment limit [1].
• Global bond index inclusion:
  • JP Morgan GBI-EM from 28 June 2024, with the weight raised to 10% by March 2025.
  • Bloomberg EM Local Currency index from January 2025.
  • FTSE EMGBI from 2025.
  • Only FAR bonds are eligible for these indices.
• FPIs held about 3.3% of outstanding G-secs (May 2026), mostly through FAR.

Don't confuse with

• T-bills vs dated securities: T-bills mature in less than a year. Dated securities have an original maturity of one year or more. States issue only dated securities (SDLs), never T-bills [5].
• Coupon vs yield: the coupon is fixed on the face value (₹7 on a ₹100 bond). The yield changes with the market price (7.37% if the bond is bought at ₹95).
• Corporate bonds: these are issued by companies and carry default risk. G-secs carry practically no default risk because the government can tax or create money.
• Oil bonds vs cash subsidy: oil bonds were non-cash securities. They kept the subsidy out of the deficit of 2005-10 and pushed the cost into later years.

Prelims Hooks

• The Government Securities Act 2006 governs G-secs. The RBI manages the Centre's debt by statute and the states' debt by agreement.
• Dated securities have an original maturity of 1 year or more. States issue only SDLs, not T-bills [5].
• Primary dealers started in 1995-96. They underwrite auctions of both Central G-secs and SDLs [6].
• Bond price and yield move inversely. A ₹100, 7% bond bought at ₹95 has a current yield of 7.37%.
• FAR (30 March 2020) allows unlimited non-resident investment in specified G-secs. The general FPI limits are 6% for G-secs and 2% for SDLs [1].
• Trap: India's first 50-year G-sec came in 2022. Capital-Indexed Bonds date from 1997. WPI-linked IIBs and CPI-linked IINSS-C date from 2013.

Mains Points

• RBI's dual role and the PDMA debate:
• As debt manager, the RBI wants low interest rates so that government borrowing stays cheap.
• As monetary authority, it may need high rates to control inflation.

• A separate Public Debt Management Agency (PDMA) would separate these two roles. But it would need a developed, liquid market and coordination between the Centre and the states, and it has not been set up.

• Global index inclusion is a double-edged sword:

• Gains: more buyers → lower yields for the government → a deeper market and money to finance the current account deficit (the gap by which a country's payments abroad exceed its earnings from abroad).
• Risks: passive "hot money" can leave suddenly → the rupee weakens → under the impossible trinity, the RBI has less freedom in monetary policy.

• Safeguards: a strong fiscal path and adequate forex reserves.

• Captive demand, financial repression and hidden costs:

• SLR keeps yields low but crowds out credit to private businesses. Retail Direct and FAR widen the investor base and reduce this dependence.
• Oil bonds and the gold-price risk on SGBs show how debt instruments can hide or postpone fiscal costs. This is the argument for transparent accounting.

Related concepts

• Dated securities
• State Development Loans
• Primary dealer
• Inflation-indexed bond
• Oil bonds
• Sovereign Gold Bond
• Fully Accessible Route
• Global bond index inclusion

Read more

• The government securities market