The Reserve Bank of India has announced the launch of Floating Rate Savings Bonds 2020 (Taxable) with an interest rate of 7.15 per cent, which will be available for subscriptions from July 1.
The coupon rate will be linked and pegged with the prevailing National Saving Certificate (NSC) rate with a spread of (+) 35 bps over the respective NSC rate.
Any fixed interest security should be analysed on the following parameters: Interest, Safety, Tenure, Liquidity, and Taxation.
Investors’ perception and expectation on these parameters may vary and one has to decide her preferred investment based on these parameters. Now, let us analyse the details of this floating rate bond and compare with other similar investment avenues like bank deposits and other deposits.
Interest and Tenure
The scheme offers an interest rate of 7.15 per cent as of now and may vary with NSC interest rate in future.
NSC interest rate is administered and NSC is a part of Small Savings schemes. The rates on such savings schemes are fixed every quarter based on yields on government bonds.
Ironically, NSC rate is fixed based on yield on government bonds and Floating Rate Savings Bond is fixed on NSC interest rate. This scheme does not distinguish between senior citizens and others and offers uniform rates for all. However, bank deposits offer higher percentages for senior citizens.
The RBI’s notification is silent on the tenure of the scheme. However, as per the Government of India, MoF Department of Economic Affairs Notification dated 26th June 2020, the bond shall be repayable after seven years.
Currently, IDFC Bank offers 7.25 per cent for a period of 5 years one day to 10 years deposits and it offers 7.75 per cent for senior citizens. PNB Housing Finance offers 8.00 per cent for 12 months to 10 years and Bajaj Finance with AAA rating from CRISIL and ICRA offers 7.85 per cent as compared to the Centre’s Floating Rate Savings Bond.
The bond offers interest at half-yearly rests whereas banks offer interest with quarterly rests. With half-yearly interest ₹10,000 would turn into ₹16,352 after seven years whereas with quarterly interest it would become ₹16,423.
Banks offer cumulative options also which means that a customer can earn interest on interest added every quarter while the bond offers simple interest every half-year without any provision for cumulative interest.
The bond scheme has foreclosure provisions only for senior citizens and shall be repayable after expiry of seven years with some relaxation for senior citizens, with three categories of lock in period of four, five, and six years for persons above the ages of 80, 70, and 60 years. Other categories cannot foreclose the deposit and wait for seven years to get maturity proceeds. The bond is not traded and hence there is no liquidity available.
Meanwhile, bank and company deposits can be foreclosed. Banks have the freedom to determine their own penal rates of interest for premature withdrawal of term deposits and most of them allow foreclosure without penalty, in addition to paying the interest applicable for the period run.
Some banks even provide partial withdrawal, nullifying the need to foreclose the entire deposit. Banks also provide loans against deposits generally up to 90 per cent of the deposit.
Foreclosure facilities also provide opportunity to look for better avenues of investment in the future.
When to opt for floating rate?
A customer has to opt for floating rate deposit, when there is an expectation that in the future the interest rate is likely to go up.
As per the RBI report, retail inflation, measured by the consumer price index, moderated for the second consecutive month in March this year to 5.8 per cent after peaking in January 2020 (RBI Monetary Policy Statement 2020-21 Dated 22 05 2020).
The RBI is mandated to maintain an inflation rate of four per cent with plus or minus of 2 per cent. Hence, we may take it that the present inflation is actually on the upper limit and RBI cannot allow this to go up. This indicates that there may not be an increase in the small savings interest rate in the coming years, implying to no increase in the bond interest rate also.
Similar to bank deposits, interest on this bond is fully taxable. Tax will be deducted at source for persons who are in the tax bracket. There is no threshold prescribed. Persons who are not under the tax bracket can give declaration and take exemption from the TDS.
Banks will affect the TDS when the interest exceeds ₹40,000 per annum and at this step too, a customer can give declaration and take exemption if he/she does not fall under the tax bracket.
As the bond is issued on behalf of the Government of India, it provides the highest safety. But banks are also under the supervision of the RBI and in the past 60 years no scheduled commercial bank has ever been allowed to close down and at the most some banks were merged with other banks and depositors’ interest was always protected. There are also finance companies with AAA ratings from rating agencies.
There is nothing in the scheme except the perception of highest safety of investment and one has to decide whether to forego better returns and convenience available with bank deposits.
In a long-term investment of seven years, even a marginal difference in interest rate will make a huge difference on the Internal Rate of Return.
(The author is a retired banker)