In July 2020, the government introduced the Floating Rate Savings Bond, with a 7.15 percent initial interest rate. These taxable bonds now have an interest rate of 7.35 percent, and it is anticipated that it will increase to 8.05 percent later this year.
It’s because the interest rate on these bonds is recalculated twice a year, in January and July, depending on the current rate for National Savings Certificates (NSC), usually with a 35 basis point (bps) premium above NSC rates. Since the government recently raised the interest rates for modest savings programmes, including NSC, to 7.70%, it is anticipated that the rate might rise by 35 basis points to 8.05%.
A purchase of floating-rate savings bonds
The bonds have a face value of 1,000 rupees and are issued in multiples of that amount. Every six months, the rate that was previously agreed is reset to coincide with the coupon payment date.
There is no upper investment restriction on these bonds. However, depending on the relevant tax status of the bondholders, interest generated on the bonds is taxable under the Income-tax Act, 1961. Tax will be withheld at source from interest payments, but exemptions are possible to those who submit a tax exemption declaration and the required supporting documentation.
Floating Rate Savings Bonds cannot be used as collateral for loans from banks, financial institutions, or non-banking financial enterprises and are not marketable on the secondary market.
The bonds have a seven-year maturity duration, but investors 60 and older may cash them out early with a minimum lock-in period of four to six years, depending on their age. For investors between the ages of 60 and 70, the lock-in period is six years from the issuance date.
Investors may protect themselves from any rate drops by locking in at the present rates. But new investments will be at cheaper rates if and when interest rates are reduced.
Future Rate Increases
The returns on government bonds are connected to NSC, a modest savings programme, which in turn is linked to the rates for floating rate savings bonds. The government has constantly sought to stop the pace of decline in modest savings plans. The Centre just announced a considerable hike in interest rates for the quarter between April and June 2023. The NSC had the biggest increase of them all, rising by 70 bps to 7.7 percent. This rate change was made in reaction to the rising trend in rates on government bonds.
In December 2022 and the prior quarter, the government last raised the interest rates for small savings programmes, ending a run of nine straight quarters with stable rates. It’s crucial to understand that inflation and the general health of the economy both have an impact on bond rates.
Predicting future changes in inflation and interest rate movements is difficult, according to Sriram Jayaraman, a SEBI-registered investment advisor and income tax planner. For those who need to generate income, Jayaraman advises investing in RBI floating rate bonds, but older folks should first use the older folks Savings Scheme (SCSS), where the cap has been raised from Rs. 15 lakh to Rs. 30 lakh. He claims that when this cap is reached, more money may be used to buy RBI variable rate bonds.
“Interest can move lower from here as in the short term we are seeing a decreasing trend in 10 year Gilt yield,” the author argues.
However, despite changes in government bond yields, NSC and other modest savings programmes’ historical rates have either kept the same or risen since June 2020. This may be ascribed to the government’s determination to keep rates competitive by including a spread to stop rates from falling. Investors should expect greater yields from floating rate bonds in the future if this trend continues.
