Government Securities Market

The government securities market in India is a crucial component of the country’s financial system. It serves as a primary avenue for the government to raise funds and provides investors with a secure investment option. Read here to learn more.

The market is regulated by the Reserve Bank of India (RBI) and plays a significant role in influencing the interest rate environment and overall monetary policy.

Recently, to add depth and liquidity to the government securities (G-Secs) market, the RBI has permitted permit lending and borrowing of G-Secs.

The RBI said G-Secs issued by the Central government excluding Treasury Bills will be eligible for lending/borrowing under a Government Security Lending (GSL) transaction.

Government securities market

The G-Secs market has witnessed significant changes during the past decade.

• Introduction of an electronic screen-based trading system, dematerialized holding, straight-through processing, the establishment of the Clearing Corporation of India Ltd. (CCIL) as the Central Counter Party (CCP) for guaranteed settlement, new instruments, and changes in the legal environment are some of the major aspects that have contributed to the rapid development of the G-Sec market.

Major participants in the G-Secs market historically have been large institutional investors.

• With the various measures for development, the market has also witnessed the entry of smaller entities such as cooperative banks, small pensions, provident and other funds, etc.
• These entities are mandated to invest in G-Secs through respective regulations.
• However, some of these new entrants have often found it difficult to understand and appreciate various aspects of the G-Secs market.

The Reserve Bank of India has, therefore, taken several initiatives to bring awareness about the G-Secs market among small investors.

• These include workshops on the basic concepts relating to fixed-income securities/ bonds like G-Secs, trading and investment practices, the related regulatory aspects, and the guidelines.

Issuance Mechanism

Primary Market:

• New issuances of government securities are conducted through auctions in the primary market.
• Auctions are typically held for both Treasury Bills and Government Bonds.

Secondary Market:

• After the primary issuance, these securities can be traded on the secondary market among investors.
• The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are key platforms for secondary market trading.

Participants in the Market

• Reserve Bank of India (RBI):
  • The RBI is the central bank and the primary regulator of the government securities market.
  • It conducts auctions, manages government debt, and implements monetary policy through open market operations.
• Scheduled Commercial Banks:
  • Banks are significant participants in the government securities market, investing in these securities to meet statutory liquidity requirements and manage their portfolios.
• Primary Dealers (PDs):
  • PDs are financial institutions authorized by the RBI to participate directly in government securities auctions.
  • They play a crucial role in market-making and enhancing liquidity.
• Non-Banking Financial Companies (NBFCs):
  • NBFCs are also active participants in the government securities market, investing in these instruments to manage their asset-liability portfolios.

Electronic Trading Platforms

• NSE and BSE:
  • The NSE and BSE provide electronic platforms for the trading of government securities in the secondary market.
  • Electronic trading enhances transparency and efficiency in the market.
• Negotiated Dealing System – Order Matching (NDS-OM):
  • NDS-OM is an electronic platform operated by the RBI for the trading of government securities among market participants.

What is a Government Security (G-Sec)?

A Government Security (G-Sec) is a tradeable instrument issued by the Central Government or the State Governments.

• It acknowledges the Government’s debt obligation. Such securities are short-term (usually called treasury bills, with original maturities of less than one year) or long-term (usually called Government bonds or dated securities with original maturity of one year or more).
• In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs).
• G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.

How are the G-Secs issued?

G-Secs are issued through auctions conducted by RBI.

• Auctions are conducted on the electronic platform called the E-Kuber, the Core Banking Solution (CBS) platform of RBI.
• Commercial banks, scheduled UCBs, Primary Dealers insurance companies, and provident funds, who maintain funds accounts (current accounts) and securities accounts (Subsidiary General Ledger (SGL) accounts) with RBI, are members of this electronic platform.

Examples of government securities include:

• Treasury Bills (Short-Term G-Secs)
• Dated Securities (Long-Term G-Secs)
• Cash Management Bills (CMBs)
• State Development Loans
• Treasury Inflation-Protected Securities (TIPS)
• Zero-Coupon Bonds
• Capital Indexed Bonds
• Floating Rate Bonds
• Savings Bonds
• Treasury Notes
• Treasury Bonds

Types of government securities

Treasury Bills (T-Bills):

• Short-term debt instruments with maturities ranging from 91 days to 364 days.
• Issued at a discount to face value, and the return is the difference between the purchase price and the face value.
• T-Bills are essentially zero-coupon bonds, meaning they don’t pay periodic interest. Investors earn returns through the difference in purchase and face value.

Cash Management Bills (CMBs):

• Cash Management Bills are short-term government securities issued to manage temporary liquidity mismatches in the government’s cash flows.
• They have a maturity period of up to 91 days and are issued at a discount to their face value.

Government Bonds:

• Long-term debt instruments with maturities ranging from 2 years to 30 years or more.
• Pay periodic interest (coupon payments) to investors, and the principal is returned at maturity.
• Most government bonds in India are fixed-rate bonds, where the interest rate remains constant throughout the bond’s life.

Dated G-secs:

• Dated G-Secs are securities that carry a fixed or floating coupon (interest rate) which is paid on the face value, on a half-yearly basis. Generally, the tenor of dated securities ranges from 5 years to 40 years.

State Development Loans (SDLs):

• SDLs are debt instruments issued by state governments to meet their financial requirements.
• SDLs function similarly to government bonds but are issued by individual states rather than the central government.
• Like government bonds, SDLs pay periodic interest to bondholders, and the principal is repaid at maturity.

Inflation-Indexed Bonds (IIBs):

• IIBs are designed to protect investors against inflation. The principal and interest payments are linked to the Wholesale Price Index (WPI) or Consumer Price Index (CPI).
• These bonds offer a fixed real rate of return above inflation, providing investors with an inflation-adjusted income.

Treasury Inflation-Protected Securities (TIPS):

• Treasury Inflation-Protected Securities (TIPS) are government securities designed to protect investors from inflation.
• The principal amount of these securities is adjusted based on changes in the Consumer Price Index (CPI).

Floating Rate Bonds:

• Floating rate bonds have interest rates that are linked to a benchmark, such as the government securities yield or other market rates.
• The interest rate on these bonds is adjusted periodically, providing investors with a variable income stream.

Capital Indexed Bonds:

• Capital-indexed bonds protect investors against fluctuations in real interest rates by adjusting the principal amount based on an inflation index.
• Similar to IIBs, these bonds offer a fixed real rate of return above inflation.

Sovereign Gold Bonds:

• Sovereign Gold Bonds are issued by the government and are linked to the price of gold.
• Investors receive periodic interest payments, and the principal value is linked to the prevailing market price of gold.

Green Bonds:

• Green bonds are issued to raise funds for environmentally sustainable projects, such as renewable energy, afforestation, or clean transportation.
• These bonds attract investors interested in contributing to environmentally responsible initiatives.

Advantages of Investing in Government Securities

Investing in government securities offers several advantages, such as:

• Safety: Government securities are considered risk-free investments due to the government’s creditworthiness and guarantee of repayment.
• Regular Income: These securities provide regular interest payments, offering a steady income stream to investors.
• Diversification: Government securities can diversify an investment portfolio by reducing overall risk.
• Liquidity: These securities can be easily bought and sold in the secondary market, ensuring liquidity for investors.
• Tax Benefits: Certain government securities offer tax benefits, such as tax exemption on the interest earned.

Challenges

Market Liquidity:  Ensuring liquidity in the government securities market is an ongoing challenge. Illiquidity can affect the effectiveness of monetary policy transmission.

Participation of Retail Investors: Encouraging greater participation of retail investors in the government securities market remains a challenge.

Conclusion

The government securities market in India is expected to continue evolving with advancements in technology, changes in market structure, and the introduction of new financial instruments. The market’s resilience and its ability to adapt to changing economic conditions will be crucial for maintaining stability in India’s financial system.

Related articles:

• Public Debt
• Capital Market
• Financial Market
• Monetary Policy of India
• Indian Financial System
• Ways and Means Advances

-Article by Swathi Satish