In recent news, the Government of India has put a halt to the subscription of the 7.75% savings (taxable) bonds, 2018. This comes following reductions in the repo rate by the Reserve Bank of India (RBI), as well as cuts to the deposit rates from banks and the small savings rate from the government. Given a preference for safe investments over high returns, investors began to demand these bonds, prompting the government to cease this investment option.
What the Withdrawal of These Bonds Means
The primary point to consider in the government’s action is that it only stops the fresh issuance of these bonds and will not affect existing investments. The 7.75% RBI Bonds 2018 were first launched on 10th January 2018, available for subscription to resident citizens and Hindu Undivided Family (HUF) members for investment into a taxable bond.
These bonds were initially introduced in 2003 as 8% GOI Savings (Taxable) Bonds, but had their interest rate reduced to 7.75% in January 2018. With a single bond valued at Rs 1,000, there was no maximum limit on investments into the bonds. These investments also came with a seven-year lock-in period but allowed for early encashment for individuals aged 60 and above. However, the income derived from these bonds is subject to taxation under the Income-tax Act, 1961.
The Reason Behind the High Demand
High Net-worth Individuals (HNIs) are the primary investors of these bonds due to the regular and cumulative income options they offer. As such, the bonds have become a preferred choice among savers, pensioners, and investors who are either exempt from tax liabilities or investing safely to generate sufficient returns. The demand for these bonds skyrocketed in the past few months following a risk-averse turn from investors.
The Reason for the Interest Rate Reduction
Interest rates are seeing a downtrend following a global projection of reduced growth rates in response to the Covid-19 pandemic. The RBI announced a 75 basis point cut on 27th March 2020, reducing the repo rate to 4.4%. This was followed by another announcement of a 40 basis-point cut on 22nd May 2020, slashing the repo rate to 4%.
The Impact of the Bonds Withdrawal
The decision negatively impacts savers and pensioners, especially in a time when returns from bank deposits have seen a steep decline due to reductions in both deposit and small savings rates. Initially, the saving bonds were guaranteed for repayment by the RBI. However, with this withdrawal, savers and pensioners must now rely on banks. This action eliminates an investment avenue that offered relatively higher post-tax returns.
Comparison to Other Options
After an April 2020 cut in the small savings rate, Public Provident Funds (PPF) interest rates fell to 7.1% (originally 7.9%). Rates for the Sukanya Samriddhi Yojana also saw a reduction to 7.6% from the initial 8.4%. Currently, the State Bank of India (SBI) offers an interest rate of 5.3% for a term deposit of 3-5 years and 5.4% on term deposits of 5-10 years.