India Public Debt and Floating Rate Bonds
(This
is for information purposes only. This should not be construed as a
recommendation or investment advice even though the author is a CFA Charterholder. Please consult your financial
adviser before taking any investment decision. Safe to assume the author has a vested
interest in stocks / investments discussed if any.)
(Floating Rate Bonds or FRBs are not to be confused with Floating Rate Saivngs Bonds, 2020 Taxable or FRSBs)
(update 20Mar2024 is available at the end of the blog with updated tables)
Public debt is the total amount of debt borrowed by a government to meet its spending needs. Governments, across the globe, borrow money from public, hence the name public debt.
India's public debt has increased by several fold in the past two decades, putting pressure on government finances in the form of higher interest burden. Public debt is raised to meet the shortfall between government expenditure and government revenue.
To put differently, citizens in India lend money to governments in India -- both central and state.
1. Components of public debt
Public debt in India has various components: It basically consists of internal debt and external debt. Internal debt consists of marketable securities and non-marketable securities. Internal debt includes borrowings raised by central government and state governments through various instruments from internal sources.
Internal sources are sources within in India, such as, commercial banks, insurance companies, other financial institutions, provident funds and corporates.
Dated securities, treasury bills and cash management bills form part of marketable securities (page 10 of the quarterly report)-- because they can be traded in secondary market.
There are some securities, like, 14-day intermediate treasury bills, securities issued to international financial institutions, securities against small savings and others, which can not be traded in secondary market. Hence, they are called non-marketable securities.
As the name suggests, external debt is debt raised from outside India. External debt is the total sum raised from foreign sources by Government of India, Reserve Bank of India (RBI) and corporates in India.
2. Government securities
A Government Security (G-Sec) is a debt obligation issued by the Central Government or the State Governments. They can be traded (buying and / or selling) in the secondary market, mainly through RBI's Negotiated Dealing System-Order Matching (NDS-OM) (anonymous online trading platform) or through over the counter (OTC) and reported on NDS-OM.
In India, the Central Government issues treasury bills, cash management bills and bonds (bonds are also known as dated securities) while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs).
India's central bank, Reserve Bank of India (RBI) is the fund manager for Government of India and state governments, raising debt from financial markets on behalf of governments.
Governments in India raise public debt through a variety of government instruments. Some of them are:
1. Dated Securities: There are a number of dated securities. Some examples are:
(i) fixed rate bonds
(ii) floating rate bonds or FRB
(iii) inflation indexed bonds (IIB)
(iv) bonds with call / put options
(v) special securities
(vi) STRIPS
(vii) sovereign gold bonds (SGB)
(viii) floating rate savings bonds, 2020 (taxable) or FRSB
(ix) sovereign green bonds (SGrB)
2. Treasury Bills
3. Cash Management Bills
4. State Development Loans (SDLs)
This article is restricted to a brief analysis of FRBs or floating rate bonds issued by RBI on behalf of Government of India.
(the blog continues below)
--------------------------------------------------The author has
written, over the years, comprehensively about Indian bond markets. If
you're interested to know more about them, here are the links:
Related Blogs on Bonds, Public Debt, G-Secs or Government Securities:
Understanding Floating Rate Savings Bonds, 2020 (Taxable) - FRSB
Mutual Fund Asset Class Returns 30Sep2023
Are Gilt Funds Attractive Now?
RBI Issues New 10-Year G-Sec Paper
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Cash Management Bills
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Primer on Market Stabilisation Scheme and Liquidity Management
Inflation Indexed Bonds (IIB)
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3. What are FRBs?
Before we understand FRBs, let us see what a fixed rate bond is. Fixed rate bonds are bonds on which the coupon rate (interest rate) is fixed for the entire life
(that is, till maturity) of the bond. Most government bonds (or securities) in India are
issued as fixed rate bonds.
As opposed to fixed rate bonds, floating rate bonds or FRBs are bonds which do not have a fixed rate coupon. Instead they have a variable coupon rate which is re-set at pre-announced intervals (say, every six months or one year). Floating Rate Bonds (FRBs) in India were first issued in September 1995.
For example, an FRB was issued on 04Oct2021 by RBI on behalf of central government. The FRB is for seven years tenure and thus will mature on 04Oct2028. And its name is FRB 2028 (because it matures in 2028). For full details on this FRB, please check Section 4, Table 2 below.
3. Outstanding amount of FRBs
As on 23Oct2023, there are six outstanding FRBs totalling Rs 4,39,749 crore, out of the total outstanding securities of central government of Rs 99,87,669 crore. The share of FRBs is only 4.4 percent of all Government of India Securities (G-Secs) outstanding.
Floating rate instruments, such as, FRBs, carry interest rate risks on re-fixing. If interest rates go up subsequent to the issue of FRB, Government of India needs to pay higher interest on FRBs, because they are re-priced at half-yearly intervals.
Likewise, if interest rates fall, the coupon rate on FRBs subsequent to their issue will come down reducing the interest burden for Government of India.
Table 1 delineates the details of FRBs outstanding:
As shown in Table 1 above, FRB 2033 has the largest outstanding of Rs 1.49 lakh crore as on 23Oct2023. And the second largest is FRB 2031 with an outstanding of Rs 1.40 lakh crore.
4. FRB 2028
Let us understand the contours of an FRB with an example.
As mentioned above, FRB 2028 was issued on 04Oct2021 and the primary auction for this was held on 01Oct2021. The FRB is for seven years tenure and thus matures on 04Oct2028. The interest on the FRB will be paid every half year, and the bond will have 14 half-yearly interest payments before its maturity on 04Oct2028.
The FRB 2028 will not carry any coupon rate. Instead, its coupon rate will be decided every half year at the time of interest (coupon) payment. The first half-yearly coupon payment, from 04Oct2021 to 03Apr2022, was 4.04 percent per annum. This rate was decided at the time of the auction, that is, 01Oct2021.
Suppose, you had invested Rs 10 crore in the bond in the primary auction held on 01Oct2021. The first coupon on this was due on 04Apr2022. And on 04Apr2022, you will be paid a an interest of Rs 20.20 lakh (that is, 2.02 percent of Rs 10 crore) for the first half-year.
The coupon rate on the FRB 2028 has two components -- consisting of a Base rate and a spread. It carries a fixed spread of 64 basis points (or 0.64 percentage points) above the base rate. The spread is fixed for the entire tenure of the bond. The spread was decided at the time of its primary auction in October 2021.
But the base rate is variable. The base rate is equal to the average of the weighted average yield (WAY) of last three auctions (from the rate fixing
day, that is, at the beginning of every half-year coupon payment period) of 182-Day Treasury Bills. The base rate formula was decided at the time of its primary auction (please see Additional Notes at the end of the blog).
The
implicit yield on the Treasury Bills changes dynamically depending on
market conditions, basically their demand and supply. Hence, the base
rate is the variable component of the floating rate bonds.
Thus, the FRB 2028 will carry a
coupon, which will have a Base rate equivalent to the average of the weighted average yield (WAY) of last three auctions (from the rate fixing
day, that is, at the beginning of every half-year coupon payment period) of 182-Day Treasury Bills, plus a fixed spread
(0.64 percent).
The coupon rate for payment of interest on subsequent semi-annual (half-yearly) periods is the average rate of the implicit yields at the cut-off prices of the last three auctions of 182-Day Treasury Bills held up to the commencement of the respective semi-annual coupon periods.
The second coupon (due from 04Apr2022 to 03Oct2022) for the FRB 2028 was fixed on 03Apr2022. It carried a coupon of 4.93 percent (base rate of 4.29 plus fixed spread of 0.64). So, on your investment of Rs 10 crore (at the time of primary auction), you were on 04Oct2022 paid Rs 24.65 lakh as interest (2.465 percent of Rs 10 crore).
The same process continues for the third coupon reset date till the maturity of bond.
Each FRB will have its own fixed spread (sometimes called as mark-up) and its own base rate formula. The base rate formula and fixed spread are decided at the time of the primary auction for each FRB differently -- depending on market conditions.
Table 2 shows the details of FRB 2028:
As shown in Table 2 above, the FRB 2028's first coupon rate was 4.04 percent and second coupon rate increased to 4.93 percent. And the third and fourth coupon rates further surged to 7.01 and 7.88 percent respectively, before cooling off to 7.69 percent for the fifth coupon.
This indicates the rising interest rate trend in Indian economy between Oct2021 and Apr2023, as RBI has raised benchmark interest rates to anchor inflationary expectations.
So, FRBs' coupon rates (which are re-set at half-yearly intervals for each FRB separately) are a pointer to the interest rate scenario in India.
5. Who invests in FRBs?
Gov't of India issues a variety of instruments of varying features and maturities such as floating rate bonds (FRBs), coupon bonds and inflation indexed bonds (IIBs) to satisfy the needs of different investors -- which would help in achieving the debt management objectives of Gov't of India.
Floating rate instruments are issued by RBI to improve the breadth and width of the G-Sec market and enable market participants to diversify their portfolio.
Floating rate instruments are issued by RBI to improve the breadth and width of the G-Sec market and enable market participants to diversify their portfolio.
Commercial banks and financial institutions prefer to invest in floating rate bonds (FRBs) for their duration management while insurance companies, provident funds and pension funds prefer to buy long-term bonds, zero coupon bonds and inflation indexed bonds (IIBs) in order to manage their liabilities.
It may be noted insurance companies and pension funds have long-term liabilities. So, they tend to invest more of their monies (assets) in long-term bonds in order to match their liabilities.
6. Floater funds
Floater funds or floating rate funds, which are a type of debt mutual funds, also invest in floating rate bonds (FRBs) issued by Gov't of India. In addition, floater funds invest in floating rate instruments issued by private corporate entities.
In India, we have only a few issuers of floating rate bonds and the floating rate bond market is not very large. As such, mutual funds use derivative tools such as interest rate swaps (IRS) to convert their fixed rate bond portfolios into a floating rate bond portfolio, depending on their interest rate outlook.
Floater funds are open-end debt schemes predominantly investing in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/ derivatives).
Floater funds are open-end debt schemes predominantly investing in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/ derivatives).
Floater Funds, as mandated by capital market regulator SEBI or Securities and Exchange Board of India, have to invest a minimum of 65 percent of their total assets in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps / derivatives).
Individual investors, who have good knowledge of interest rate scenarios, can invest in floater funds if they think interest rates are going to rise in future and of course, depending on their investment objectives.
However, interest rate movements in an economy are hard to predict.
To Sum Up
Floating rate bonds or FRBs are bonds issued by Government of India. They are sovereign bonds and payment of principal and interest are fully guaranteed by Gov't of India and as such they are considered 100-percent safe as long as the Gov't of India does not default.
However, they carry interest rate risk. In any rising interest rate environment, prices of FRBs may go up and in a declining interest rate scenario, prices of FRBs tend to fall.
Unlike fixed rate bonds, interest rates of floating rate bonds are variable and are generally reset every half year. If an FRB with half-yearly reset has a maturity period of eight years, it will have sixteen different interest rates.
Each half-yearly interest rate will be decided at the start of a new interest rate period. An FRB's interest rate has two components -- consisting of a base rate plus a fixed spread.
RBI has allowed retail public in India the option of investing in government securities (including FRBs) and other government instruments through its Retail Public Portal. If you are interested in investing in government bonds directly, you can check the RBI Portal for details.
However, unsophisticated and young investors may be better off investing their surplus money via debt mutual funds which offer a range of schemes, like floater funds and liquid funds, to suit their various investment needs and goals.
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P.S.: After writing the blog, the following updates are added with new information / images:
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Additional Notes:
2. RBI Press Release 15Nov2001 - an example for calculating the variable Base rate for FRB 2006 (5-year tenure) is given here. The base rate formula was fixed some days before the actual auction. The base rate formula is: The variable base rate will be the average rate of the implicit yields at cut-off prices emerging in the immediate previous six auctions of ‘Government of India 364-Day Treasury Bills’ held prior to the relative half-year coupon period. (The illustration given in the press release is good for understanding the calculation of Base rate for FRBs.)
The primary auction for FRB 2006 was done on 21Nov2021 -- during the auction, the base of FRB 2006 for the first half-year coupon period was fixed as 7.06% (as per base rate formula as stated above) and the mark-up (fixed spread) was fixed as minus 0.05% or minus five basis points -- so, the first semi-annual coupon rate was fixed as 7.01% (= 7.06 - 0.05). FRBs can have negative fixed mark-up or spread.
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References:
RBI: List of Govt of India Securities Outstanding as on xxx (updated every week)
RBI database - Table 110: Outstanding Liabilities of Central Government (since 1980-81 to 2022-23) (it's hard to access this page: RBI DBIE > click publication > Public debt statistics > Internal debt - marketable > GOI Dated Securities > Table 12 - Outstanding Liabilities of Central Government) -- from this navigation, one can access 'Ownership Pattern of Govt of India Securities' also -- from 'Ownership Pattern of Govt of India Securities,' one can access 'Outstanding Liabilities of Central Government' data every quarter from Jun2015 till Jun2023 -
RBI weblink - (data as at close of Jun2023) Ownership Pattern of Central and State Govt Securities; and Treasury Bills -- provided once in a quarter as 'Occasional Series' in RBI Bulletin ( for example, in Oct2023 -- RBI Bulletin is published monthly) -- total outstanding is given, in addition to percentages owned by banks, insurers, etc., are given -
RBI Public Debt Statistics - weblinks, like, O/S G-Secs, time series on pubic debt, Quarterly report on Public Debt Management, Handbook of Statistics on Indian Economy, etc., are available
RBI Public Debt Management 30May2023 (part of RBI annual report)
GOI Ministry of Finance - Public Debt Management quarterly reports
GOI Public Debt Management - Apr-Jun.2023 quarterly report
GOI Ministry of Finance - Status Paper on Gov't Debt for 2021-22 -- gives a lot of data on: (treasury trove of data)
- outstanding central gov't dated securities from 2000-01 to 2021-22
- internal and external debt from 2000-01 to 2021-22
- Debt Management Strategy
-Public debt
- FRB data
- maturity profile of dated secs
- ownership pattern of dated secs
- SGB data
- residual maturity of G-Secs
- weighted average maturity of G-Secs
- FPIs and VRR
- rollover risk
RBI Debt Management Strategy for India 31Dec2015 - a good document on PDM
RBI Annual Report dt 30May2023 - full PDF (RBI annual reports provide data on public debt management and various other data points)
RBI Annual Report dt 21Aug2014 - full PDF
Tweet / Post X thread dt 28Oct2023
Tweet / Post X thread dt 26Feb2017
RBI FAQs on Government Securities Market in India
Several Tweets (thread) / Post X on Special Securities - tweet 19Sep2018 - another tweet 19Sep2018 -
India External Debt - Ministry of Financne
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Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.
Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.
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