Floating rate bonds: a sophisticated version of inflation indexed bonds

A pall of eclipse glossed one of the secured investment abodes in India on 28th May 2020. RBI announced subscription cessation of its 7.75% Savings bonds w.e.f 28th May 2020. Such bonds were the only respite available to investors, then. Whilst, deposit rates  were edging decade low trajectories. It was widely anticipated, that the scheme would open up again, with a slight tweak in its rates. In a previous instance, the bond rates were reduced to 7.75% from 8%. The FRSB (Floating Rate Savings Bond) is indeed a bolt from the blue!! FRSB is supposed have substituted the erst while 7.75% savings bond offered by RBI.

Components of FRSB: As the name the suggest, the interest rates are kept buoyant, in line with NSC (National Savings Certificate) rates. An additional spread of 0.35% is being offered over the NSC rates, since investors have to bear an additional lock-in period of 2 years on comparison with NSCs. NSC are locked for 5 years (in the least), where as FRSBs for 7 years. Remarkably, NSCs earn a fixed rate of interest till maturity, on the contrary FRSB returns are floating. Incumbent, FRSB rates have been pegged at 7.15% (NSC 6.8% + 0.35%). Forthcoming rate amendment is scheduled for January 2021. These bonds do not enjoy liquidity until maturity, as they are not tradable.

A comparison with its peers: FRSB rates might instinctively appear to be superior as they enjoy a spread over NSC rates. Bear in mind, FRSB rates are kept floating. For instance, a post office NSC invested today shall earn a fixed 6.8% p.a untill 2025, where as FRSB ones are not reliable despite their 0.35% spread. Even, FDs payout a fixed return till their maturity. For an investor seeking assured returns, FRSB is not an appropriate option.Currently, Suryoday small finance bank offers the highest rate of interest 9% for FDs with 5 years duration. With the deposit insurance in place, principal and interest up to 5 lakhs stands assured. However, the quantum and frequency of (NSC) rate changes will eventually prove the attractiveness of FRSBs in the market, with monetary easing dominating the present economic scenario.

FRSB from tax perspective: Constituents of small savings scheme (PF, NSC etc) are available for deduction under Section 80C. FRSB is devoid of that privilege. The half yearly interest payouts are regally taxable under the slab rates prevalent. FRSB might be attractive for an investor opting for the new-slab rates (devoid of exemptions).

Who should opt in FRSB? An investor seeking absolute safety of principal shall opt in for FRSBs. Since the bonds does not have the option to accumulate interest, reinvestment risk of the bi-annual payouts stands open-ended. The same shall appear as a virtue for an investor seeking regular returns, but must bear the risk of floating returns. An investor, who has exhausted his limits with tax saving schemes can park his surplus in FRSBs.

To conclude with, RBI did try a floating exchange investment scheme previously. It was the inflation-indexed bonds (IIB) launched in 2013.The rationale behind the IIB is as follows – Principal invested in Rs 1000. Coupon rate is 5%. Inflation rate prevalent CPI- Consumer price index is 10%. At the year end, interest payment will be 5% * (1000 *110/100), which tantamount to Rs 55. The interest gets calculated on adjusted principal. On maturity, adjusted principal / invested principal which so ever stands higher, is paid out to the investor.  Hence, principal stands insulated even in years of deflation. Though a spread was offered over the inflation rate, since the latter stands volatile, these bonds were perceived to be floating rated ones and were not well received in the economy.

If comprehended intrinsically, FRSB would appear akin to Inflation indexed ones. FRSB rates are linked to NSC ones, which in turn are linked to government bond yields, which in turn are directly driven by the inflation experienced in the economy. In my opinion, RBI has tried out the second version of inflation indexed bonds under a different form….

Published by adithyaarunachalam

I'm a millennial, from Chennai, India. Passionate about building up a career in finance, I follow and stay abreast on news feeds. I'm a novice blogger, So feel free to pass on your conjecture to me @adithyaarunachalam@Gmail.com

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