Savings Bonds: Will RBI’s 2020 Floating Rate Savings Bonds Give You a Positive Real Return? here is the math


By Dr Neelam Rani and Prudhvi Sankar

RBI Floating Rate 2020 Savings Bonds are bonds issued by the Government of India, with an interest rate of 7.15%. The interest rate on these bonds will reset every six months (mentioned below). The bonds were made available for subscription on July 1, 2020, and you can invest in these bonds through public sector banks and some private sector banks such as HDFC Bank, Axis Bank, ICICI Bank and IDBI Bank. RBI has already opened subscriptions for the Bonds through the 16 authorized Banks.

Bonds are issued only in electronic form and held in the Bond Ledger Account (BLA). The BLA is an account with the RBI or a bank branch in which bonds are held. The investor, in this case, receives a certificate of detention from RBI / Agency Banks.

Main characteristics of the Bonds

  • The Bonds are open for subscription by resident individuals and HUFs. Individuals can invest in bonds individually or jointly.
  • The Bonds bear a variable interest rate which is reset every six months, the first reset falling on January 1, 2021. Payments of the Bond are made semi-annually on January 1 and July 1 of each year.
  • Investments can be made in multiples of Rs.1000 with a minimum of Rs.1000. There is no cap on the maximum amount that may be invested in the Bonds.
  • The Bonds bear a variable interest rate calculated at 0.35% (ie 35 basis points) above the benchmark interest rate in force for National Savings Certificates (NSCs). The NSC interest rate is linked to the yield on 5-year / 10-year government securities and is reset by the government on a quarterly basis. This implies that the market rate ultimately plays a role in determining the floating interest rate of current bonds. NSC interest rates are reported by the government on a quarterly basis.
  • The Bonds have a fixed term of 7 years. However, early withdrawals are allowed (only for individual investors) subject to a minimum lock-up period based on the age of the holder.
Age group of the individual investor Blocking period from the date of issue
60 to 70 years old 6 years
70 to 80 years old 5 years
80 years and over 4 years

In the event of early collection, 50% of the interest due during the last six months of the holding period is recovered on the product and the product is paid on the next interest payment date.

  • The Bonds do not carry any benefit under the Income Tax Act and the interest income is fully taxable.

Let’s take a closer look at these obligations by weighing the pros and cons.

Should you invest in variable rate savings bonds?


High interest rates: The attractive feature of the Bonds is clearly the higher interest rates. The Bonds inherently offer a high interest rate, as the interest rate is set at 35 basis points above the prevailing NSC rates. The current NSC rate is 6.8%, which effectively sets the interest rate on the Bonds at 7.15% for the first six months. Interest rates are reset semi-annually and the current interest rate on bonds is higher compared to other investment options like NSC (currently 6.8%), fixed deposits with banks, public provident fund (currently 7.1%).

Floating interest rate
: The interest rate on the Bonds is based on the variable rate system. Floating interest rates ensure that investors receive interest based on market interest rates or rather the interest rate offered on NSC. If interest rates rise, the benefits can be expected to be passed on to investors, but remember that the interest reset period is 6 months and the rate will only increase. when the NSC interest rate increases.

Risk-free investment option: The bonds are risk free as they are offered by the Indian government. Thus, variable rate savings bonds offer another investment option for risk averse investors and for investors looking to diversify their portfolios.

Fixed income
: Investors will receive periodic and regular income from the Bonds in the form of interest payments. This leaves investors the choice to use their income, either for savings or for consumption.


Taxable bonds
: Tax exemptions and deductions are one of the key considerations for an investor to choose an investment option. The Current Bonds do not carry any kind of tax benefits, either in the form of deductions under Chapter VI A of the Income Tax Act, or exemptions for interest income from the Bonds. The lack of tax advantages for the Bonds makes them relatively less attractive to tax-paying investors who are already using other alternative investment options.

Interest rate risks
: Since the Bonds bear a variable interest rate and the interest rates are reset periodically, investors are exposed to interest rate risk. Interest rate risk is the risk resulting from falling interest rates. Right now with the impact of COVID and low growth expectations, the interest rate risk is expected to persist for some time.

Not combinable
: Interest on the Bonds is paid periodically to investors and there is no option for cumulative interest. Passive investors may lose the cumulative effect of the amount of interest paid to investors.

: The transferability restrictions (except in the event of the death of the Holder), the unavailability period criteria for premature withdrawals and the non-negotiability of the Bonds make them illiquid. In addition, investors cannot avail of any loans from financial institutions (both banks and NBFCs) with the bonds as collateral.


So for whom will these bonds be a suitable investment?

As these bonds offer a variable interest rate that would be reset as explained above, investors can expect bond yields to be able to beat inflation over the long term. However, the taxation of the Bond remains a key consideration for investors.

These bonds can be viewed as an investment by all investors for whom the real rate of return on these bonds, that is, the return net of inflation and taxes, is positive. As inflation is variable, the real return may therefore vary over time for all investors.

Below is an analysis of the suitability of these bonds based on the actual rate of return and current tax rates –— for different groups of investors.

In order to understand the impact of inflation and tax rates on semi-annual interest payments, a sensitivity analysis is performed.

The analysis captures the sensitivity of the semi-annual return (for a single semi-annual period) to the current bond interest rate, inflation and tax rates.

To facilitate the calculation, the bond interest rate and the inflation rate are offset to arrive at “average inflation interest” (positive is beneficial for investors).

Interest on Variable Rate Savings Bonds (applicable for the current semester) a 7.15%
Current CPI inflation b 6.09%
Interest on inflation (positive is beneficial for investors) a B 1.06%

Based on the individual tax rates of the existing regime, the tax rates of 0%, 5%, 20% and 30% are taken into account for the analysis.

The area highlighted in red indicates the area to be avoided. On the other hand, if my tax rate is 10% and the Interest (-) Inflation rate is 1%, Bonds might be attractive to an investor.

When assessing the suitability of these bonds, the investor should keep in mind that while the inflation rate is currently above 6%, it may not always remain so, so inflation has fluctuated. between 1.97% and 7.59% over the past 3 years.

The summary of the above analysis is below:

Applicable tax rate *
0% The tax will have no impact.
5% The actual return will be positive if the expected deviation of ‘CPI interest rate inflation (-)’ is at least 0.4%
20% The real return will be positive if the expected deviation of ‘CPI interest rate inflation (-)’ is at least 1.5%
30% The real return will be positive if the expected deviation of ‘CPI interest rate inflation (-)’ is at least 2.2%

Note: The above analysis is for educational purposes only and not for advisory purposes. Actual analysis may vary when other details such as surcharges and taxes are factored in.

(Dr Neelam Rani is Associate Professor (Finance) at the Indian Institute of Management Shillong. Prudhvi Sankar is CA and alumnus of IIM Shillong.)


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