Interest Rate for Government Bonds – Logic behind Interest Rate

What is Interest Rate for Government Bonds?

When a government of India issues the bonds it will generally make regular interest payments during the life of the Gov Bond and repay the initial investment, or principal amount, when the bonds expire on their ‘maturity date’.
Generally, short-term bonds are known as Treasury Bills in India with a maturity of less than one year.
T-bills are available with different maturity periods ranging from 91 days to 365 days.
On the other side, bonds with a maturity of more than a year, ranging from 5 to 40 years are long-term securities knows as Government Bonds (i.e. Dated Securities).
Both the central and state governments can issue government bonds. Though, the bonds issued by state governments are also known as State Development Loans (i.e. SDLs).
In this article, we will discuss in detail about the Interest Rate for Government Bonds India in 2021.

Interest Rate for Treasury Bill

Treasury Bill do not carry an interest component. Actually, this is the main difference between T-bills and Bonds.
In other words, these bills are zero coupon securities and pay no interest. Instead, they are issued at a discount and redeemed at the face value at maturity.
These bills are issued at a discount to their PAR i.e. Par value (also called the true value), and upon expiry, it’s redeemed at its true value.

Let’s take an example to understand the calculation of discount value in a better manner.
For instance, assume the Par Value, is INR 100/-. This T-bill is issued in person at a discount to its PAR, Say INR 96/-. After 91 days, person will get back INR 100/-, and so person makes a return of INR 4/-.
In other word, this is as good as buying a stock at INR 96/- and selling it after 91 days at INR 100/-.
The only difference is that this is a guaranteed transaction, meaning, there is no risk of you selling below INR 100/- (or above INR 100/-).

Considering the same details as above, let us know the exact formula of Treasury Bills rate.

The formula is –

Y = (D/P)*(365/N)

Y = Yield
D = Discount Value
P = Bond Price
N = Number of days to maturity

Y = [4/96]*[365/91] = (0.041)*(4.01) =16.7%

Therefore, the treasury bill offers a return on investment of 16.7%. However, since you held it for 91 days, you will enjoy this return on a pro-rata basis.

Logically, 91-day yields are around 6-8%. Needless to say, the higher the yield, the better it is.

Interest Rate for Government Dated Securities Bonds

Here’s what you need to know about the Dated Securities rates.

RBI Bonds or Government of India Savings (Taxable) Bonds

The RBI Bonds do not have a fixed interest rate and it is reset every 6 months.
This bond will continue to fetch the same interest rate, i.e., 7.15% till the next reset date of July 1, 2021.
Logically, the interest rate of this bond is linked to the prevailing rate on NSC i.e. National Savings Certificates scheme, with the RBI Bonds paying out 0.35% more than the NSC rate.
Though, investors should note that the term of NSCs is 5 years compared to 7 years on the RBI Bonds.

For example, the prevailing NSC rate is 6.8%. Now adding another .35% to the NSC rate, i.e. 6.8% + .35% = 7.15%, the interest rate for the RBI Bonds he interest rate (payable on July 1, 2021) was decided.
Similarly, the new rates would be reset on July 1, 2021 depending upon the then NSC rate.

Sovereign Gold Bonds

Sovereign Gold Bonds (SGBs) currently have a fixed rate of 2.50 per cent per annual, which is remitted twice a year on the nominal value.

When it comes to the nominal value of the SGB, it is generally based on the simple average closing price for gold of 999 purity of the last three working days of the week preceding the subscription period.
The value of the bond would be what was published by the IBJA i.e. India Bullion and Jewellers Association.

The final instalment of interest will be payable on maturity along with the principal.
Its returns are generally linked to the prevailing market price of gold.

In other words, if the gold price rises after eight years, the returns will be higher along with an ensured 2.5 per cent of interest rate. If the gold price falls, the returns will be on a lower side. However, it does not affect an investor’s unit of gold. Check the below table of historical data of gold

IINSS-C (Inflation Indexed National Savings Securities-Cumulative)

The interest rates of IINSS-C has two components.
One is the fixed component, which is 1.5 per cent, the other is the floating component, which is linked to CPI i.e. consumer price index.

Let’s take a look at one example, suppose CPI inflation is at 12 per cent then this bond will fetch you 13.5 per cent return (fixed rate (1.5%)+CPI rate (12%)=13.5%.).

To get more idea checkout historic CPI inflation data given below

• As a result, the interest rate will fluctuate along with the inflation rate. However, it will not turn negative in case of deflation and will not fall below 1.5 per cent even if the inflation turns negative.
• Interest will be accrued and compounded in the principal on half-yearly basis and paid along with principal at the time of redemption.

Interest Rate for Government Tax Free and Tax Savings Bonds

• Tax Free Bonds

The rate of interest offered on tax-free bonds generally ranges between 5.50% to 6.50%, which is fairly attractive when considering the tax exemption on interest for these bonds.

If the company issues the Tax Free Bonds, it can be purchased from them (i.e. primary market).
Currently no such bonds are available in the primary market. Therefore, You will have to wait for the public issue of these bonds.
Though, these bonds are also available in the secondary market and may come at a premium due to falling interest rate. Hence, the only option is to buy them from the secondary market – NSE or BSE.

• Tax Savings Bonds

The Tax Savings Bonds offer an interest rate of 5.00% per annum. However, Interest earned on the bonds is taxable.
NHAI and REC Capital Gain Bonds have cut the interest rate on their capital gains bonds from 5.75% to 5% from August 2020.
The lower rate will only apply to new bonds where payment by the concerned institution has been received after 1 August 2020.