RBI Retail Direct for govt bonds: Who should use it and who should not

Last Updated on November 14, 2021 at 9:44 am

RBI Retail Direct – a facility that allows retail investors to open gilt security account with the RBI and purchase government securities (gilt bonds or gilts) in the primary and secondary market without a fee – was launched on Nov 12th 2021. In this article, we discuss who should use it and who should not.

Retail investors can already participate in the gilt primary market via NSEGoBid and Zerodha and in the gilt secondary market via select demat providers. RBI Retail direct now offers a single portal for both markets.

Retails investors can buy bonds in the primary market (after a bond is issued) via a process known as non-competitive bidding. When RBI announces G-secs, the price is determined in an auction by banks and institutional investors (big players). While retail investors can now participate in this auction, they cannot bid for these bonds. The price allotted will be decided by the bids of the big players.

RBI Retail Direct allows the sale of the bonds mid-tenure via CCIL India’s NDS-OM (Negotiated Dealing System – Order matching segment). The entire process of registration and use is completely online and can be linked with a savings bank account. The full scope of RBI Retail Direct has been published by RBI.

In this article, we will focus on who should use RBI Retail Direct and who should not. To do this, we must understand the basics of bond buying and selling.

When you buy a bond, you will get regular interest payments. Typically twice a year. This interest is taxable as per slab. There is no cumulative option available (save for some exceptions). The interest must be declared each year and tax paid each year.

So this should tell us who should not be using RBI Retail Direct and who should be!

• If you need regular income for a specified duration, then buying govt bonds will be useful. You can consider buying 20Y, 30Y, 40Y govt bonds as an additional source of pension. This can be done via NSEGoBid. See for example: Can I get a pension using GOI bonds instead of LIC pension? And 40Y GOI Bonds with a 6.8% interest rate on sale 24th and 25th Nov 2020.
• You will not be able to sell these bonds if purchased via NSE Gobid. You can sell via RBI Retail Direct. However, just because you can sell does not mean you will be able to! The price of long term bonds will be extremely volatile, and a retail investor may typically sell to only other retail investors. The big boys would only be interested in large volumes. So unless someone is willing to buy, you cannot sell. Also, you should be ready to face a loss upon sale.
• There is a small chance that the bond may be recalled by the govt. mid-term. So this means you may have to buy a newer bond at possibly a lower interest rate.

Thus, if you need regular long-term income govt bonds can be used as one of the sources. Please note such income will preserve the principal and, therefore, cannot keep pace with inflation. So other sources are essential. See for example: Creating the “ideal” retirement plan with income flooring!

Who should use RBI Retail Direct? Only those who need regular long-term income should buy govt bonds from RBI Retail direct. If you do not need income, it makes no sense to use RBI Retail Direct. A govt bond is not tax-efficient and should not be used for short-term or long-term accumulation portfolios (unless, of course, you have a lot of money to spare!).

Govt short-term bonds, including money market bonds (treasury bills), are also of little use and should be avoided. A simple RD or FD can get this done for those who wish to avoid debt mutual funds.

Can I buy govt bonds using RBI Retail Direct for a long-term portfolio instead of debt mutual funds? Please avoid. The tax paid on interest will reduce gains (this applies to FDs and RDs as well). Instead, invest the principal prudently to beat inflation in a balanced asset allocation. A gilt mutual fund can be used by those who can stomach market volatility. Others can consider a money market fund. The credit risk is reasonably low in both fund categories.

I don’t need income immediately, but can I buy long-term govt bonds to lock in the higher interest rates? Please do not. It would be a waste of principal, which could be invested elsewhere and a waste of tax paid on the interest.

I need income for five years, so can I buy a five-year gilt bond?  Yes, you can.

Why is the govt introducing RBI Retail Direct? We think the aim is (over the long-term) retail participation will increase market depth and reduce price-demand mismatches (this can shoot up during a crisis like the March 2020 crash). This is perhaps decades away. Therefore we recommend that retail investors do not get excited about trading in gilt bonds for capital gains.

In summary, do not buy gilt bonds as a replacement for debt funds or FDs. Buy gilt bonds only if you desire regular income (typically long-term).  Those who are retired and close to retirement should ensure that such income is part of a diversified retirement portfolio.