The government securities market

Detail

1. What a G-sec is

• Government security (G-sec) = a debt paper that the government sells to borrow money. The buyer lends money to the government. The government promises to pay interest and return the money on a fixed date.
• It is tradable, which means the holder can sell it to someone else before it matures.
• It is issued by the Centre or the states.

• It carries practically no default risk, because the government can raise taxes or create money to repay. That is why it is called a "gilt-edged" or risk-free asset.

• Two types of G-sec, by length of the loan:

• Short-term: Treasury Bills (T-bills) and Cash Management Bills (CMBs), which are for less than a year (see section 2).

• Long-term: dated securities. RBI defines these as securities with an original maturity of one year or more [6].

• Who issues what:

• The Central Government issues both T-bills and dated securities.
• State governments issue only dated securities, called SDLs [6].

2. Legal and institutional basis

• Legal basis: the Government Securities Act 2006 governs how G-secs are issued, transferred and held.
• RBI as the government's debt manager:
• RBI manages the Centre's debt by statute (under the RBI Act 1934).

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

• The PDMA debate:

• Public Debt Management Agency (PDMA) = a proposed separate body that would take over government debt management from RBI.
• The conflict of interest:
  • As debt manager, RBI wants low interest rates so that government borrowing stays cheap.
  • As monetary authority, RBI may need high interest rates to control inflation.
  • One body is trying to meet two goals that can pull in opposite directions.
• The idea has been discussed for many years but has not been put into effect.

3. Dated securities: mechanics

• Coupon = the fixed interest rate a bond pays, worked out on its 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.
• The coupon is paid half-yearly.

• Worked example: a ₹100 bond with a 7% coupon pays ₹7 a year, which comes as ₹3.50 every six months.

• Maturity usually runs from about 2 to 50 years. India issued its first 50-year bond in 2022.

• Bond price and yield move in opposite directions (Class 12, leec103).
• Yield = the actual return a buyer earns, given the price they pay.
• Current yield = annual coupon ÷ market price × 100.
• Worked example:
  • Market interest rates rise, so the old 7% bond is less attractive and its price falls to ₹95.
  • Current yield = 7 ÷ 95 × 100 = 7.37%.
  • So when price falls, yield rises, and when price rises, yield falls.
• Why this matters: when RBI raises rates, banks that hold many bonds see the value of those bonds fall. This is called mark-to-market loss.

4. State Development Loans (SDLs)

• SDLs = dated securities that states sell through RBI auctions to borrow from the market.

• 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 over central G-secs of the same maturity. A spread is the extra yield that investors ask for.

• Worked example: a 10-year G-sec yields 6.8% and a 10-year SDL yields 7.2%. The spread is 0.4 percentage points, or 40 basis points (1 basis point = 0.01%).

• Investors see state finances as slightly riskier and SDLs as harder to sell quickly, so they want more return.

• Details are in fiscal-federalism.

5. Primary dealers (PDs)

• Primary dealer (PD) = an entity authorised by RBI to do two jobs:
• Underwrite G-sec auctions. Underwriting means promising to buy any part of an auction that other bidders do not take up.

• Make markets in G-secs. This means always quoting a buy price and a sell price, so that other investors can trade easily.

• PDs were introduced in 1995-96, as part of the 1990s market reforms.

• There are two kinds:
• Standalone PDs, which are separate companies.

• Bank-PDs, which are banks that run PD business departmentally.

• PDs may underwrite dated securities of both the Government of India and state governments [7].

• RBI sets activity rules for PDs: their turnover ratio in outright deals must be at least 3 times in dated G-secs and 6 times in T-bills/CMBs [7].
• Turnover ratio = how much a PD trades in a year compared with the securities it holds.

6. Market plumbing

• NDS-OM (Negotiated Dealing System – Order Matching): RBI's electronic, anonymous screen for trading G-secs in the secondary market.
• Primary and secondary market:
• Primary market: the government sells new bonds, through auctions.

• Secondary market: investors trade existing bonds among themselves.

• Non-competitive bidding:

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

• RBI introduced this to bring small investors into primary G-sec auctions [6].

• RBI Retail Direct (November 2021):

• Individuals can open a Retail Direct Gilt (RDG) account with RBI through an online portal [4].
• With this account they can:
  • Buy in primary auctions through non-competitive bids.
  • Buy and sell in the secondary market on NDS-OM, in the "Odd Lot" and "Request for Quote" segments [4].

• Later additions:

  • a mobile app (May 2024);
  • an auto-bidding facility for T-bills, which places bids and reinvests automatically [5].

• SLR (Statutory Liquidity Ratio): banks must keep a set share of their deposits in liquid assets, mostly G-secs (Class 12).

• This makes banks captive buyers, meaning they must buy G-secs by rule, not by choice.
• Their steady demand keeps government borrowing costs low.

• Critics call this financial repression: savers' money is pushed into government debt instead of loans to businesses.

• OMOs (Open Market Operations): RBI buys or sells G-secs in the open market (Class 12).

• RBI buys G-secs → it pays out money → banks have more cash → liquidity rises.
• RBI sells G-secs → it takes money back → banks have less cash → liquidity falls.

7. Special G-secs

• Inflation-indexed bond (IIB) = a bond whose principal or coupon rises with inflation, so the investor's real return (return after inflation) is protected.
• 1997: Capital-Indexed Bonds, where only the principal was indexed.
• 2013: WPI-linked IIBs, and CPI-linked IINSS-C (Inflation Indexed National Savings Securities–Cumulative) for retail investors.

• Why they stopped:

  • Demand was weak.
  • The 2013 IIBs were linked to WPI (wholesale prices), while households feel CPI (retail) inflation.
  • The market for them was thin, so they were hard to sell.

• Oil bonds = non-cash securities given to oil marketing companies (OMCs) in 2005-10. They made up for the OMCs selling petrol, diesel, LPG and kerosene below cost.

• Result: the subsidy did not show up in the deficit of those years. The fiscal cost was pushed into later years.
• Interest and principal are being repaid through the 2020s.

• They are often cited to justify high fuel taxes.

• Sovereign Gold Bond (SGB) = a G-sec denominated in grams of gold, launched in November 2015.

• Aim: reduce imports of physical gold, which widen the current account deficit (CAD). CAD is the gap by which a country's payments abroad for imports and similar items exceed its earnings from abroad.
• Interest: 2.5% a year on the issue value.
  • Worked example: issue price ₹5,000 per gram gives ₹125 a year per gram.
• Tenure: 8 years. Early exit is allowed after the 5th year, on a date when interest is due [3].
• Redemption price:
  • It equals the simple average of the closing price of 999-purity gold over the previous 3 business days, as published by the India Bullion and Jewellers Association (IBJA) [3].
  • Example: ₹7,231 per unit for redemption due on 30 April 2024 [3].
• Capital gains on redemption are tax-free.
• No fresh tranche since February 2024.
  • The government bears the gold-price risk.
  • Gold prices rose sharply, so repaying investors became very costly.

8. Foreign access to the G-sec market

• FPI (foreign portfolio investor) = a foreign investor who buys financial assets such as bonds and shares without taking control of a company.
• FPI debt investment works within limits set under a medium-term framework.

• Under this framework the limits are 6% of outstanding central G-secs and 2% of outstanding SDLs [2].

• Fully Accessible Route (FAR) (introduced by RBI circular of 30 March 2020):

• It lets non-residents invest in specified G-secs with no investment limit [2].
• All FPI investment that already existed in those specified securities was counted under FAR [2].

• RBI publishes the list of FAR-eligible securities [2].

• Global bond index inclusion = adding a country's bonds to global bond indices.

• Passive funds (index funds that copy an index automatically) must then buy those bonds.
• Timeline:
  • JP Morgan GBI-EM from 28 June 2024. The weight was raised in steps to 10% by March 2025.
  • Bloomberg EM Local Currency index from January 2025.
  • FTSE EMGBI from 2025 (verify current).

• Only FAR bonds are eligible for these indices. This is why FAR matters.

• FPIs held about 3.3% of outstanding G-secs (May 2026), mostly through FAR (verify current).

• Benefits:
• The government gets lower yields because there are more buyers.
• The market becomes deeper, with more trading and better price discovery.

• Foreign money helps finance the CAD.

• Risks:

• Sudden outflows: passive money leaves automatically if index weights change or global risk rises.
• Rupee pressure: when foreigners sell bonds and take dollars out, the rupee weakens.
• Impossible trinity: a country cannot have all three of free capital flows, a fixed exchange rate and independent monetary policy at the same time. More foreign inflows mean RBI has less freedom in monetary policy (see balance-of-payments-exchange-rate).

Prelims Hooks

• Government Securities Act 2006 governs G-secs. RBI manages the Centre's debt by statute and the states' debt by agreement.
• Dated securities = original maturity of 1 year or more. States issue only dated securities (SDLs), not T-bills [6].
• Primary dealers were started in 1995-96. They underwrite auctions of both Central G-secs and SDLs [7].
• Bond price ∝ 1/yield. Example: a ₹100 bond with a 7% coupon, bought at ₹95, has a current yield of 7.37%.
• FAR (30 March 2020): no limit on non-resident investment in specified G-secs. The general FPI limits are 6% for G-secs and 2% for SDLs [2].
• RBI Retail Direct (November 2021): individuals open a Retail Direct Gilt (RDG) account with RBI. They trade on NDS-OM and bid non-competitively in auctions [4].
• SGB: 2.5% interest a year, 8-year tenure with exit after year 5, redemption price = average of the IBJA 999 gold price over 3 days, capital gains tax-free on redemption, no new issue since February 2024 [3].
• Oil bonds (2005-10) are non-cash securities. They move fiscal cost to later years; they did not provide cash subsidy at the time.
• JP Morgan GBI-EM inclusion began on 28 June 2024, with weight rising to 10% by March 2025.
• Trap: India's first 50-year G-sec came in 2022. Capital-indexed bonds date from 1997; WPI-linked IIBs date from 2013.

Mains Points

• RBI's dual role and the PDMA:
• RBI both sets interest rates and sells the government's debt, which creates a conflict of interest.
• A separate PDMA would make the roles clear.

• But it would need a developed, liquid market and coordination between the Centre and states.

• Global index inclusion as a double-edged sword:

• It brings cheaper government borrowing, finance for the CAD and a deeper market.
• It also brings "hot money" (money that leaves quickly), rupee swings and the limits of the impossible trinity.

• A strong fiscal path and adequate forex reserves are the safeguards.

• Captive demand versus market discipline:

• SLR and bank holdings keep yields low, but they crowd out credit to the private sector.

• Retail Direct and FAR widen the investor base. They also reduce dependence on "financial repression".

• Off-budget and contingent liabilities (liabilities that are not shown in the budget, or that arise only if some event happens):

• Oil bonds and the gold-price risk of SGBs show how debt instruments can hide or postpone fiscal costs.
• This makes the case for transparent accounting and prudent choice of instruments.