From UPSC perspective, the following things are important :
Prelims level : G-Secs
Mains level : Read the attached story
Government Securities (G-Secs) yields are at an all-time high.
What are G-Secs?
- These are debt instruments issued by the government to borrow money.
- The two key categories are:
- Treasury bills (T-Bills) – short-term instruments which mature in 91 days, 182 days, or 364 days, and
- Dated securities – long-term instruments, which mature anywhere between 5 years and 40 years
Note: T-Bills are issued only by the central government, and the interest on them is determined by market forces.
- Like bank fixed deposits, g-secs are not tax-free.
- They are generally considered the safest form of investment because they are backed by the government. So, the risk of default is almost nil.
- However, they are not completely risk-free, since they are subject to fluctuations in interest rates.
- Bank fixed deposits, on the other hand, are guaranteed only to the extent of Rs 5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC).
How are G-sec yields calculated?
- G-sec yields change over time; often several times during a single day.
- This happens because of the manner in which G-secs are structured.
- Every G-sec has a face value, a coupon payment and price.
- The price of the bond may or may not be equal to the face value of the bond.
- Here’s an example: Suppose the government floats a 10-year G-sec with a face value of Rs 100 and a coupon payment of Rs 5.
- If one were to buy this single G-sec from the government, it would mean that one will give Rs 100 to the government today and the government will promises to 1) return the sum of Rs 100 at the end of tenure (10 years), and 2) pay Rs 5 each year until the end of this tenure.
- At this point, the face value of this G-sec is equal to its price, and its yield (or the effective interest rate) is 5%.
How do G-sec yields go up and down?
- Imagine a scenario in which the government floats just one G-sec, and two people want to buy it.
- Competitive bidding will ensue, and the price of the bond may rise from Rs 100 (its face value) to Rs 105.
- Now imagine another lender in the picture, which pushes the price further up to Rs 110.
What do G-sec yields show?
- If G-sec yields (say for a 10-year bond) are going up, it would imply that lenders are demanding even more from private sector firms or individuals; that’s because anyone else is riskier when compared to the government.
- It is also known that when it comes to lending, interest rates rise with the rise in risk profile.
- As such, if G-sec yields start going up, it means lending to the government is becoming riskier.
- If you read that the G-sec yields are going up, it suggests that the bond prices are falling. But the prices are falling because fewer people want to lend to the government.
- And that in turn happens when people are worried about the government’s finances (or its ability to pay back).
- The government’s finances may be in trouble because the economy is faltering and it is unlikely that the government will meet its expenses.
- By the reverse logic, if a government’s finances are sorted, more and more people want to lend money to such a G-sec.
- This in turn, leads to bond prices going up and yields coming down.
Try this PYQ:
Consider the following statements:
- The Reserve Bank of India manages and services the Government of India Securities but not any State Government Securities.
- Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.
- Treasury bills offer are issued at a discount from the par value.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 3 Only
(c) 2 and 3 only
(d) 1, 2 and 3
Post your answers here.