Government Securities or G-Secs are debt instruments issued by the Indian government to finance its fiscal deficit. G-Secs are considered safe investments as they carry the sovereign guarantee of the Indian government. One of the key factors that determine the attractiveness of G-Secs is their yield, which is the return that an investor earns on the investment. In this article, we will discuss the Government Securities Yield in India.
Understanding Government Securities
Before we delve into the concept of prevailing yield, it’s important to understand what government securities are. Government securities are debt instruments issued by governments to raise money. These securities are backed by the full faith and credit of the government and are generally considered to be low-risk investments. Examples of government securities include treasury bills, treasury notes, and treasury bonds.
What is Prevailing Yield?
Prevailing yield refers to the current yield on a particular government security. It is the yield that an investor would receive if they were to purchase that security at its current market price. In other words, it is the yield that is currently being offered by the market for that particular security.
What is Prevailing Yield of Government Security?
The prevailing yield on a government security refers to the interest rate that is currently being offered for the security. It is the return that the government pays to investors who hold securities. This yield is determined by market forces of supply and demand and may change over time. The prevailing yield of a government security is an important factor for investors to consider when making investment decisions. A higher yield may attract more investors, while a lower yield may cause some investors to look elsewhere for higher yields.
Advantages of investing in Government Security
The following is the advantages of investing in Government Security:
- Sovereign Guarantee: Government bonds have a premium status with respect to the stability of the funds and the promise of guaranteed returns. Since G-Secs are a form of formal statement of government debt obligation, they mean a commitment by the issuing government body to repay according to specified terms.
- Adjusted for Inflation: Balances held in inflation-indexed bonds are adjusted against the rising average price level. In addition, the principal invested in equity-indexed bonds is also adjusted for inflation. This feature gives investors an advantage as they are less susceptible to financial undermining, as investments in such funds increase the real value of the deposited funds.
- A regular source of Income: As per RBI regulations, interest income from government bonds is supposed to be paid to these debt holders every six months. It provides an opportunity for investors to earn a regular income by investing their unused funds.
Why does Prevailing Yield of Government Security Matters?
Prevailing yield is an important metric for investors to consider when evaluating government securities. The prevailing yield can provide investors with a sense of the current market demand for a particular security. A security with a higher prevailing yield may indicate that there is less demand for that security, which could be a signal of perceived higher risk. On the other hand, a security with a lower prevailing yield may indicate that there is high demand for that security, which could be a signal of perceived lower risk.
Additionally, prevailing yield can help investors compare the relative value of different government securities. For example, if two securities have similar characteristics, but one has a higher prevailing yield, that security may be a better investment opportunity.
Factors affecting the Prevailing Yield of Government
The prevailing yield is influenced by a number of factors such as;
- The most important of these is the current economic situation in the country. If the economy is strong and growing, then the prevailing yield may be higher because investors are more willing to lend money to the government. On the other hand, if the economy is weak and struggling, the prevailing yield may be lower because investors are less willing to lend money to the government.
- Another factor that can affect the prevailing yield is the perceived risk associated with government securities. If investors perceive a security as risky, they may demand a higher yield to compensate for that risk. On the contrary, if investors perceive the security as safe, then they may accept a lower yield.
- The prevailing yield can also be influenced by the actions of the central bank. For example, if the central bank increases interest rates, the prevailing yield on government securities may also increase. This is because investors will demand a higher return on government securities to offset the higher interest rates offered on other investments.
How are Government Security Yields calculated?
G-sec yields change over time, often several times in one day. This happens because of the way G-seconds are structured. Each GSEC has a face value, a coupon payment, and a price. The bond price may or may not equal the face value of the bond.
Here’s an example: Suppose the government offers a 10-year G-sec with a face value of Rs 100 and a coupon payment of Rs 5. If a person were to buy this single G-sec from the government, it would mean giving the government Rs 100 today and the government promising to 1) return the Rs 100 at the end of the tenure (10 years) and 2) pay Rs 5 every year until the end of this term.
At this point, the face value of this G-sec is equal to its price, and its yield (or effective interest rate) is 5%.
What do Government Security Yields show?
G-Secs are the safest investments in any economy, and the G-sec yield is the lowest risk-free interest rate in any economy. As such, they are a good way to gauge the broader trend of interest rates in the economy. If G-sec yields (say on the 10-year note) rise, that would mean lenders are demanding even more from private sector firms or individuals; that’s because anyone else is riskier compared to the government.
It is also known that when it comes to lending, interest rates rise as the risk profile increases. So if G-sec yields start to rise, it means lending to the government is getting riskier.
If you read that G-sec yields are rising, it indicates that bond prices are falling. But prices are falling because fewer people want to lend money to the government. And that, in turn, happens when people worry about the government’s finances (or its ability to pay).
Government finances may be in trouble as the economy falters and the government is unlikely to meet its expenses.
How does G-Sec Yields Increase and Decrease?
Imagine a scenario where the government floated just one G-sec and two people wanted to buy it. A competitive bid will follow, and the price of the bond may rise from Rs 100 (its face value) to Rs 105. Consider another lender entering the picture and raising the price to Rs 110.
But here’s the big deal: The G-sec coupon payment is still Rs. 5.
So, if you bought a bond at Rs 100, the yield is 5%, but if the price of the bond rises to Rs 105, the yield falls; it becomes 4.76% as the other person gets Rs 5 against the investment of Rs 105.
Further, if the bidding results in the price going to Rs 110, then the third party (who eventually bought the bond at Rs 110) will find that the yield has further fallen to 4.54% because the third party would invest Rs. 110 for the same return of Rs. 5.
Impact of Yield on Government Securities on the Economy and Current Yield on Government Securities in India
As of April 2023, the yield on 10-year government securities in India is around 6.5%. The yield on government securities has been on an upward trend since mid-2022 due to rising inflation and expectations of an increase in interest rates by the RBI. The yield on 10-year government securities was around 5.75% in April 2022, and it has increased by around 75 basis points in the past year.
The yield on government securities in India has a significant impact on the economy. Higher yields on government securities lead to higher borrowing costs for the government, which leads to higher fiscal deficit and consequently, higher inflation. It also leads to higher interest rates for borrowers in the economy, which can slow down economic growth.
Conclusion
The yield on government securities in India is an important indicator of the economic health of the country. It is influenced by various factors such as inflation, economic growth, and the monetary policy of the RBI. The current yield on government securities in India is around 6.5%, and it has been on an upward trend due to rising inflation and expectations of an increase in interest rates by the RBI. The impact of higher yields on government securities on the economy can be significant and needs to be carefully managed by the government and the RBI.
