RBI Retail Direct Gilt (RDG) Scheme

What is RBI Retail Direct

RBI Retail Direct is a platform provided by our federal bank and aimed at facilitating investment by retail investors in gilts by improving ease of access and providing a direct portal for individual investors.

Why Gilt

Gilt stands for Government Issued Long Term. When we say Gilt Funds, we mean debt based mutual funds which invest in Gilt securities (also called as G-Secs).

G-secs witness the highest volumes within the fixed income market since they offer a risk-free rate i.e. there is virtually no credit risk. Retail investors could thus far participate in G-secs only through Debt based Mutual Funds. As an example, we can invest in something like a Nippon Direct Gilt Fund, whose underlying securities are majorly G-Secs.

However, in debt funds, investors have to invest with a minimum 3-year investment horizon through the Growth option to qualify for long-term capital gains wherein they are taxed at the rate of 20% of the gains with indexation benefit. 

The RBI Retail Direct Scheme will now enable retail investors to participate in G-secs across various tenors with flexible investment horizons and the ability to get regular cash flows through risk-free coupons. This brings the Gilt securities at par with stocks, where the investors already have a choice to either take the mutual fund route or directly buy the underlying securities from their trading and securities account.

How to invest in RBI Retail Direct

Retail investors (individuals) will have the facility to open and maintain the ‘Retail Direct Gilt Account’ (RDG Account) with the Reserve Bank of India (RBI).

The RDG Account can be opened online through the RDG Portal provided specifically by RBI for the purpose of the scheme.

Registration on the online portal will require the filling of an online form and a one-time password which shall be received on the registered mobile number.

After successful registration, investors can either purchase the government bonds through primary debt sales, or in the secondary market. The government holds primary auctions every Friday, with the sales being conducted by the government's debt manager.

How much can we invest

A retail investor can do a minimum investment of INR 10,000 and a maximum investment of INR 2 crores via this platform.

More about the RDG Account

An individual can open only one RDG account. The RDG account can be opened singly or jointly with another retail investor who meets the eligibility criteria. The second holder in a joint RDG account may also open an individual RDG account. 

The biggest positives of RDG Account

There are 3 positives which I clearly see:

a/ Safety: As already stated, we are buying G-secs which have effectively no credit risk. However, almost the same safety is assured when we buy gilt mutual funds.

b/ Cost Effectiveness: Retail Direct Gilt Account is completely free of charge and does not involve any intermediary. It would reduce overall transaction charges for individual investors in terms of the charges which they are otherwise required to pay for investing through aggregators or taking indirect exposure through debt based mutual funds. This is where they truly score over debt mutual funds.

c/ Predictable cash flows over a very long tenure: For investors looking for predictable fixed cash flows for long tenures like 30 to 40 years, it doesn't get better than this. Debt Mutual Funds typically invest for a maximum of 10 years maturity and then the re-investment returns depends on the interest rates at that time, thus posing volatility to the cash flow - which could go on either side. Returns, therefore, remain unpredictable.

Safety, predictability and cost effectiveness are its biggest positives.

Where does it fail

Everything sounds good until we dig deeper. Here is why this investment is likely to fail.

a/ Inefficient taxation: There is absolutely no tax break that is currently available on RDG. Unless the retail gilt investment plan is accompanied by tax benefits such as those offered through mutual funds and small savings schemes, meaningful fund flows may not occur.

b/ Poor Returns vis-à-vis Small Savings Instruments (SSI): In India, fixed-income products such as small savings schemes or debt mutual funds offer better returns. Small Savings Instruments (SSI) – the interest rate of which is set by the government - pose the biggest challenge to the scheme. The interest rates of SSIs (like PPF, EPF, NSC, SSY etc.) are based on a formula, suggested by the Shyamala Gopinath Committee in 2016, which is linked to the yields of government securities. Although yields have hardened over the last six months, interest rates of the SSIs have been left unchanged, for political reasons. In fact, for the last six quarters the interest rates have not been changed by the government. 

Sukanya Samriddhi Yojana accounts, for instance, earn 7.6% and the Debt GILT funds offer on average 8.77% through a 10-year period - both significantly higher than what RDG offers (6.5% to 7%).

And, of course, Small savings instruments are just as safe as government security from a retail investor point of view.

c/ Wrong timing: The retail direct scheme comes at a time when interest rates have bottomed out and are expected to go up. Yields have already hardened over the last few months. Bond prices and yields are inversely related. Yield will harden once the central bank starts raising interest rates and as a result, returns to bond holders will fall. Of course, this is true for Debt Mutual Funds as well, but unlikely for small savings instruments, which are likely to continue enjoying political protection.

The Special Case for NRIs

NRIs are allowed to buy these government bonds through their NRO bank accounts. 

Given that interest rates in developed markets are in the range of 1-2%, the yield of 6.5-7% on Government of India bonds attracts NRI investors. Typically, a bond maturing in 2050 is currently available at a yield of 6.91%, while those maturing in 2058-2061 can give a yield of 7- 7.1%. NRIs get certainty of cash flows as these bonds give a fixed return. They can handle all the investments online. Also, NRIs cannot invest in small savings schemes such as PPF, KVP and NSC. 

Thus, this might look attractive to NRIs to a certain extent. NRIs from the US and Canada also face restrictions from mutual fund houses and very few allow them to invest. 

However, for NRIs, there is always a rupee depreciation risk, as the local currency is known to depreciate every year, and thus the returns are nullified by that much amount. A 3% depreciation in the currency would mean the effective returns tapering down to 3 to 4%.

Despite small hiccups, no credit risk, easy application process via a digital platform, lower transaction charges and predictable cash flows make it a viable option for non-resident investors to lock in their funds for a long time.

How does it compare with RBI Floating Rate Bonds

RBI Floating Rate Bonds with a 7 year lock in are currently offering 7.15% and since they are floating rate, the interest rate is likely to go up as and when RBI raises the interest rates. RDG is unable to match these interest rates even for 30-40 year bonds. 

Both RDG and RBI Floating Rate Bonds pay interest semi-annually and there is no cumulative option. Both are fully taxable. The only advantage with RDG would be long-tenure products give the investor an option to lock in investments at that rate, giving predictability of cash flows. Short-tenure products carry reinvestment risk, making it difficult to plan cash flows, as interest rates could change on maturity. 

Where can RDG succeed

There are two use cases where I see RDG succeeding:

a/ Annuity: Retail Direct bonds can be an alternative to LIC annuity plans as retail investors can invest in the longest maturity until 2061.

b/ NRIs: NRIs looking for a steady income stream from long-tenure debt products to meet their parents’ cash flows, or to maintain their property back in India, would want to buy these bonds.

Official RBI FAQs

If you have more questions, you can refer to the original RBI FAQ list here.

Summary

RBI Retail Direct is likely to fall flat as returns from the scheme are much less attractive compared to other available options, especially if you look at the post tax returns. Small Saving Instruments are not going to allow this to succeed, since many of them like PPF, EPF enjoy tax immunity. And then the wrong timing. For now, it is definitely a No Go for a common retail investor. For NRIs and someone looking for life long pension, they can give it a thought.

Regards

Manoj Arora
Official Website