Make the best of RBI’s new Retail Direct debt scheme

In the two weeks since its launch, the Reserve Bank of India’s Retail Direct Scheme (RBI-RD) has received a rockstar reception. It has been flooded with registrations by retail investors looking to pick up government bonds, or gilts. Joining the bandwagon are non-resident Indians (NRIs), who have for long had very few options to invest in the Indian debt market.

Till the launch of RBI-RD, as a retail investor, you could put in your funds in gilts only through the institutional route. For instance, you could either invest in gilt mutual funds (MFs), or buy the bonds via G-Sec (government securities) dealers.

Low levels of investor awareness and liquidity, apart from high minimum investment amount and complex procedures, were keeping lay investors off gilts. The RBI’s latest scheme lets you invest in them directly — fully online, with zero charges. However, since there is no institutional buffer, you need to work a tad bit more to put the scheme to best use.

The RBI has detailed information on the scheme through an FAQ.

What the RBI has introduced

The RBI has basically opened up an investment avenue that was earlier closed to retail investors. “This scheme is democratising the gilt market,” said TR Somasundar of Bengaluru-based Shilpa Associates, which handles equities and MF assets. “Until now, individual investors were handicapped by lack of liquidity, high minimum amount, etc,” he told The Federal. “Mutual funds were the only option for the knowledgeable.”

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Now, you can open an account at the RBI’s Retail Direct Gilt (RDG) portal, and immediately start investing in the debt market — both primary and secondary (where you can buy and sell). You can make and receive payments for the transactions through internet banking or Unified Payments Interface (UPI).

The portal comes with customer support via email and a toll-free number. You can download transaction and balance statements, make nominations, and carry out various other tasks at the click of a button. None of this is charged.

Tap these advantages

The fact that you can open an account and make any number of transactions for zero charges is the among the greatest pluses of the RBI-RD. There is no intermediary or aggregator who will bill you for services, or collect it from the other party and therefore eat into your gains. Plus, the rates are better than bank fixed deposits.

You can choose from four types of securities: Government of India Treasury Bills (T-Bills), Government of India dated securities (dated G-Sec), State Development Loans (SDL), and Sovereign Gold Bonds (SGB). Since they’re all issued by the government, they are 100% safe, in that your principal remains intact if you keep them till maturity.

This scheme is ideal if you are looking at a long-term investment, say 10 or more years. For instance, if you are an NRI looking to support your parents in India, or maintain a property here, you can use this scheme to get a steady income for decades, as you can lock in investments at the current interest rate.

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The same logic works for domestic investors, too. “People with long-term money seeking capital safety can park their money here for regular annual income. The returns should mimic the bank returns. And there is scope for capital gains, too,” observed Somasundar.

The interest rate vs bond rate conundrum

The biggest drawback, say wealth managers, is the interest rate risk. This means if the interest rate on the security you hold goes up, the bonds freshly floated in the market — with higher interest — will become more attractive than what you have in hand. New investors will prefer those to buying from you in the secondary market, since yours will continue to draw the rate that you’d locked in. So, you may need to offer your bonds at a discount.

To give you a very rough example, suppose you buy a bond for ₹100 at 7% interest rate. The next year, if the interest rate is increased to 8%, new buyers will obviously prefer those bonds. So, you will need to mark down the price of your bond — say, to ₹95 — so that the buyer finds it as attractive as a new bond for which he’d have to shell out ₹100.

The reverse is true, too. If the interest rate goes down, the market value of your bonds will go up. Either way, it’s a dynamic market and you need to work out the math. It’s rather complex math, but there are bond calculators available online that you can use to gauge the market value of your bonds at potential interest rates. Once you have the numbers, you can compare them with investing via MFs, factoring in the add-on costs there, to see what gives you better returns.

The long-term bet looks safest

The above rule applies when you plan to resell your gilts. If you hold them till maturity, you can largely curtail mark-to-market losses. Not only will you get the principal in full but also the regular interest payouts at the rate you locked in. “Long-term investors should not worry because their interest returns remain the same until maturity. In fact, they should invest more when the price falls,” explained Somasundar.

This, of course, applies to all debt products and not just to RBI-RD instruments. But when you buy them via MFs, you have a qualified fund manager handling the equations; when you invest directly, you’re fully in charge.

Either way, the exposure to debt should ideally be limited, said Somasundar.  “Don’t be over exposed to gilts. The interest rate risk is a major issue unless you are holding till maturity,” he said. “Pure gilt funds from MFs are a good alternative. Easy and simple — you can do an SWP (systematic withdrawal plan) for interest income.”

And then there’s tax, and liquidity

The Centre has not announced any tax exemption for investments via RBI-RD, similar to ones given for other debt instruments such as small savings schemes and RBI floating rate bonds. The interest earned on G-Secs is taxed in the hands of the investor, per income tax slabs.

At present, G-Sec investing is plagued by low secondary market liquidity in retail lots (where individuals can dabble). The situation is expected to improve over a period of time, but that’s not a given. Financial advisers expect greater clarity on the scheme — with some amendments regarding tax and liquidity — to emerge in the coming days.