RBI’s floating rate savings bonds – Decoding the investment option

• Interest is paid every six months, i.e. on January 1 and July 1.
  
• The interest rate on floating rate bonds is linked to a benchmark interest rate, such as the national savings certificate (NSC) rate.
  
• Floating rate bonds are backed by the Government of India, thus making it very safe.
  

Recently the Reserve Bank of India (RBI) revealed that it has set the annual interest rate for the Government of India Floating Rate Bond (FRBs) at 8.05% for the duration spanning from October 30, 2023, to April 29, 2024.

RBI FRBs are debt securities issued by the RBI. The interest rate on FRBs is linked to a benchmark interest rate, such as the NSC rate. The interest is set at 35 basis points above the NSC rate.

In other words, this means that the interest rate on FRBs will fluctuate over time, depending on the movements in the benchmark interest rate.

Features of RBI floating rate bonds

FRBs have several features that make them a good investment option for investors looking for a low-risk investment with regular income. Interest is paid every six months on January 1 and July 1 every year and there is no option to get cumulative interest. The interest rate on FRBs is reset every six months.

“This is more like a fixed deposit, coming in the name of a bond, where you give the money to RBI, get interest every six months and after the lock-in period you get back your principal,” says B. Srinivasan, director and founder, Shree Sidvin Investment Advisors.

FRBs have a maturity period of seven years. The minimum investment amount for FRBs is ₹1,000, while there is no maximum limit. FRBs are backed by the government of India, making it one of the safest investments.

Risks associated with floating rate bonds

However, there are also some risks associated with investing in FRBs.

If the interest rate on NSC goes up, the RBI FRB will offer a higher interest rate. If the interest rate goes down, the bonds will offer a lower interest rate. This is the reason why they are called floating rate bonds.

Also, these bonds are non-transferable and non-tradeable. They are not liquid as they have a 7-year lock-in period. However, senior citizens have an option of liquidating it after a shorter lock-in period.

Should you invest?

Like any investment opportunity, the main question is what are the pros and cons of such a scheme. “It depends. If the RBI keeps on holding the rate, investors may keep on getting 8.05% for some period of time. If the rate falls, then it is a risk because you will be getting very low returns. If you are ok to manage that, then take a position. Remember, it is not a debt mutual fund which you can buy and sell,” says Abhishek Kumar, founder and chief investment advisor at SahajMoney, a financial planning firm.

These bonds are suitable for people who are looking for regular income and more cautious about their safety. “For a 8.05% risk free return, and someone who has the need to go for a regular income without much of a tax consideration, this will be a very good product. This will not be a good product for people in the accumulation stage, but it is good for people who are looking for distribution,” says Srinivasan.

It is important to remember that the majority of the regular income comes in on a monthly basis, here it will come in a half-yearly basis.

Let us take an example to see how you can manage your payouts. Let us say you are investing ₹10 lakh in FRBs. Then you will get an interest of ₹80,000 per year. So you are expecting something around ₹7,000 a month. The first six months you will not get any interest.

So instead of ₹10 lakh, you invest ₹9.6 lakh. Then the balance of ₹40,000 will take care of the first six months “Then the cash flow will be smoothening out,” says Srinivasan.

While RBI’s floating rate bonds are risk-free, when the interest rate is higher than the rate that is on offer, you earn no real returns. Which brings us to the moot point that it may not be a suitable product if one is looking to grow wealth for a long term goal.