G-Secs: structure and current dynamics

 A government security (G-Sec) is a debt obligation of the Indian government to fund their fiscal deficit. These instruments are tradable and are issued either by the central or the state government. These securities are offered for short term as well as long term. Short-term instruments with a maturity of less than one year are typically called treasury bills (T-Bills) whereas long-term instruments are called government bonds or dated securities with a maturity of one year or more.

However in India, the central government issues T-Bills as well as bonds or dated securities while the state government issues only the bonds or dated securities called State Development Loans (SDL). The central government also issues not fully tradable savings instruments like savings bonds, national saving certificate etc or special securities like oil bonds, fertilizer bonds, power bonds etc.

Developments in the G-Sec Market
During 2017-18, the 10-year G-sec yield altered significantly. Following factors affected it:
• Announcement of new benchmark security index, lower inflation, positive monsoon forecast, dovish stance of monetary policy and rating upgrade reduced yield
• Higher CPI inflation, additional supply of securities through OMO sales, rise in oil prices leading to concerns of higher inflation, and higher government borrowings exerted upward pressure on yields

Economic Survey 2017-18 Inputs on G-sec

During 2017-18 (up to 11th January, 2018), the direction of movement of the 10-year generic G-sec yield altered significantly. In April 2017, G-secs traded with a moderate hardening bias, after the release of the minutes of the Monetary Policy Committee meeting on April 20, 2017, which enunciated upside risks to inflation. However, the G-sec yield softened sharply after May 12, 2017 mainly on account of auction of a new benchmark security coupled with lower than expected inflation for April 2017. Between May 2017 and July 2017, G-secs traded with a softening bias on account of better than expected economic data viz., lower inflation, positive monsoon forecast and dovish stance of monetary policy in June 2017. The softening of yield was further supported by robust FPI inflows.

Later, from mid-July to November 17, 2017, the yield movement was mainly guided by global factors and reflected a hardening bias in the US. Furthermore, domestic factors such as, higher CPI inflation, additional supply of securities through OMO sales, rise in oil prices leading to concerns of higher inflation, and higher government borrowings, exerted upward pressure on yields. India’s sovereign rating upgrade by Moody’s, however, briefly led to a decline of the 10-year G-sec yield to 7.10 per cent on November 20, 2017, but it went back up later. The G-sec yield as on January 11, 2018 stands at 7.26 per cent.

Types of G-Sec

1. Treasury Bills (T-bills): T-bills are money market short term debt instruments which are issued by the central government in three tenures mainly 91-day, 182-day and 364-day. These instruments are zero coupon bonds which pay no interest but are actually issued at a discount and redeemed at the face value at maturity.

2. Cash Management Bills (CMBs): CMBs are a new short-term instrument having common characteristic of T-Bills but with a maturity of less than 91-days. These instruments are issued to meet the temporary disparity in the cash flow of the government. CMBs too are issued at a discount and redeemed at face value on maturity.

3. Dated Government Securities: These instruments are long-term securities which carry a fixed or floating coupon (interest) rate paid on the face value, which is payable at fixed time periods generally half-yearly. The maximum tenure of these securities is 30 years.

Types of dated instruments:

Fixed Rate Bonds – These bonds have their coupon rate fixed throughout the maturity. The majority of government bonds are issued as fixed rate bonds.
Floating Rate Bonds – These bonds do not have fixed coupon rate. The coupon rates for these bonds are re-set at the pre-announcement intervals (every six months or 1 year) by adding a spread over a base rate. The base rate is the weighted average cut-off yield on the last three 364-day T-Bills auctions prior the coupon re-set interval while the spread cut-off is decided through the auction.
Zero Coupon Bonds – These bonds are issued at a discount to the face value with no coupon rates.
Capital Indexed Bonds – These are bonds where the principal is linked to an accepted inflation index in order to protect the holder against inflation. The government is planning to issue Inflation Indexed Bonds wherein the final wholesale price index (WPI) will be used for indexation. As per the proposed structure, the principal will be indexed and the coupon will be calculated on the indexed principal.
Bonds with Call or Put Options – These bonds are issued with a feature of buyback option (call option) for the issuer or the sell option (put option) for the investor at par value (equal to face value) after the completion of five years from the date of issuance on any coupon date falling thereafter.
Special Securities – It is a long-term dated security carrying coupon rate with a spread of about 20-25 basis points over the yield of the dated securities of comparable maturity. These bonds are issued by the central government to the oil marketing, fertilizer companies etc as compensation in place of cash subsidies. These companies raise cash by divesting these securities in the secondary market to banks, insurance companies etc.
STRIPS (Separate Trading of Registered Interest and Principal of Securities) - STRIPS are instruments wherein each cash flow of the fixed coupon security is converted into a separate tradable zero coupon bond. For instance, when Rs 100 of the 8% GS2020 is stripped, each cash flow of coupon (Rs 4 each half yearly) will become coupon STRIP and the principal payment (Rs 100 on maturity) will become a principal STRIP. These cash flows are traded separately as independent securities in the secondary market. STRIPS have zero reinvestment risk.
State Development Loans (SDLs)

These dated securities are issued by state government to raise loan from the market through an auction wherein the interest is paid half yearly and the principal is repaid on maturity.

How are G-Secs issued?

These securities are issued through auctions conducted by the RBI on the electronic platform called the NDS (Negotiated Dealing System) – Auction platform. The central bank in consultation with the central government issues an indicative half-yearly auction calendar which contains information about the borrowing amount, tenor and the likely period during which auctions will be held. A notification or press release giving exact particulars of the securities and procedure of auction is issued by the government about a week prior to the actual date of auction.

Types of Auctions

Yield Based - A yield based auction is generally conducted when a new government security is issued.

Price Based - A price based auction is conducted when government re-issues securities issued earlier.

Depending upon the method of allocation to successful bidders, auction could be classified as

Uniform Price Based – Successful bidders are required to pay for the allotted quantity of securities at the auction cut-off rate, irrespective of the rate quoted by them.

Multiple Price Based - Successful bidders are required to pay for the allotted quantity of securities at the respective price/yield at which they have bid.

Investors may bid under following categories:

Competitive Bidding – Under this bidding an investor bids at a specific price/yield and is allotted securities if the price/yield quoted is within the cut-off price/yield.

Non-Competitive Bidding - This bidding is open to individuals, HUFs, RRBs, co-operative banks, firms, companies, corporate bodies, institutions, provident funds and trusts. Under this bidding eligible investors apply for a certain amount of securities in an auction without mentioning a specific price/yield and are later allotted securities at the weighted average price/yield of the auction.

Major players in the G- Sec market

Commercial banks and primary dealers besides institutional investors like insurance companies are the major players. Other players include co-operative banks, regional rural banks, mutual funds, provident and pension funds. FIIs are allowed to participate within the quantitative limits prescribed from time to time whereas corporates buy or sell these securities to manage their overall portfolio risk.

Role of Clearing Corporation of India Limited (CCIL)

CCIL is the clearing agency for G-Sec and it acts as a central counter party for all transactions between two counterparties.

By: Abhishek Sharma