Gilt-edged securities

Gilt-edged securities are high-grade debt instruments issued by a national government or its agencies, considered among the safest forms of investment. The term “gilt-edged” originates from the British practice of printing government bonds with gilded edges to signify their superior credit quality. These securities are characterised by negligible default risk, steady returns, and high market liquidity, making them a preferred choice for conservative investors, financial institutions, and central banks.

Background and Concept

The concept of gilt-edged securities emerged in the United Kingdom, where the government issued bonds to finance public expenditure and wartime needs. The term “gilts” became synonymous with UK Government Bonds, backed by the full faith and credit of the British government. Over time, many other nations, including India, adopted similar instruments to raise funds for budgetary and developmental purposes.
In India, gilt-edged securities refer primarily to Government of India securities (G-Secs), which include both long-term and short-term debt instruments. These are issued by the Reserve Bank of India (RBI) on behalf of the central government and, in some cases, by state governments. The objective is to mobilise funds for financing fiscal deficits, infrastructure projects, and other public welfare programmes.

Features of Gilt-Edged Securities

Gilt-edged securities exhibit several distinctive features that make them secure and attractive to investors:

• Sovereign Guarantee: Fully backed by the government, eliminating the risk of default.
• Fixed Returns: Offer fixed or semi-annual interest payments (coupon payments) and repayment of principal on maturity.
• Long-Term Nature: Typically issued for periods ranging from 5 to 40 years.
• High Liquidity: Actively traded in the secondary market, ensuring easy transferability.
• No Credit Risk: Considered virtually risk-free due to the government’s commitment to honour repayments.
• Marketability: Can be easily sold in the open market before maturity.
• Denomination and Form: Issued in electronic form through the Negotiated Dealing System (NDS) and held in Subsidiary General Ledger (SGL) accounts.

Types of Gilt-Edged Securities

Gilt-edged securities encompass a variety of instruments issued by the government to suit different investment and policy objectives:

1. Government of India Dated Securities (G-Secs): Long-term instruments with fixed coupon rates and specified maturity dates.
2. Treasury Bills (T-Bills): Short-term securities with maturities of 91, 182, or 364 days, issued at a discount and redeemed at face value.
3. State Development Loans (SDLs): Bonds issued by state governments to finance developmental projects.
4. Zero-Coupon Bonds: Issued at a discount without periodic interest payments, redeemed at par value on maturity.
5. Inflation-Indexed Bonds (IIBs): Provide protection against inflation by linking returns to the inflation rate.
6. Floating Rate Bonds (FRBs): Feature variable interest rates that adjust periodically based on a benchmark rate.

Mechanism of Issue and Trading

In India, the Reserve Bank of India (RBI) manages the issuance and trading of gilt-edged securities through various mechanisms:

• Primary Market: The government issues securities through auctions, where banks, insurance companies, and institutional investors participate. The bidding process can be competitive (price determined by bid) or non-competitive (allocated at average auction price).
• Secondary Market: After issuance, gilts are traded among investors in the Negotiated Dealing System – Order Matching (NDS-OM) platform operated by the RBI. Retail investors can also access them through the Retail Direct Scheme, allowing direct investment without intermediaries.

Interest payments are generally made semi-annually, and the securities can be held until maturity or traded for capital gains.

Investors in Gilt-Edged Securities

Gilt-edged securities attract a wide range of investors due to their safety and reliability:

• Commercial Banks: Hold gilts to meet Statutory Liquidity Ratio (SLR) requirements.
• Insurance Companies and Pension Funds: Prefer government securities for long-term stability and regulatory compliance.
• Mutual Funds: Use gilts to diversify portfolios and reduce credit risk exposure.
• Foreign Institutional Investors (FIIs): Participate under approved investment limits in Indian debt markets.
• Retail Investors: Gain access through mutual funds, gilt funds, or the RBI’s Retail Direct portal.

Advantages of Gilt-Edged Securities

• Safety of Principal: Backed by the government’s repayment obligation.
• Regular Income: Provide fixed, predictable interest income.
• Liquidity: Can be easily traded or pledged for loans.
• Portfolio Diversification: Offer a low-risk component in investment portfolios.
• Benchmark Yield: Serve as a reference point for determining interest rates on corporate bonds and other debt instruments.
• Monetary Policy Tool: Used by the central bank for open market operations (OMOs) to control liquidity and interest rates in the economy.

Limitations and Risks

Although gilt-edged securities are virtually free from default risk, they are not entirely devoid of other risks:

• Interest Rate Risk: Bond prices fall when market interest rates rise, affecting investors who sell before maturity.
• Inflation Risk: Fixed coupon payments may lose real value during high inflation periods.
• Low Yield: Returns are generally lower than those from corporate bonds or equities due to minimal risk.
• Liquidity Risk (for some issues): Certain older or less-traded securities may face reduced marketability.

Role in the Indian Financial System

Gilt-edged securities play a central role in India’s financial and monetary framework. Their significance can be viewed through multiple dimensions:

• Government Financing: Enable the central and state governments to fund fiscal deficits.
• Banking Regulation: Used by banks to satisfy SLR obligations, ensuring liquidity and stability in the financial system.
• Monetary Control: The RBI conducts open market operations by buying or selling gilts to manage money supply and interest rates.
• Yield Curve Formation: Act as benchmarks for pricing other fixed-income instruments in the market.
• Safe Haven Asset: Provide investors with a secure investment avenue during periods of economic uncertainty.

Market Developments and Innovations

Over the past two decades, India’s gilt market has undergone substantial modernisation:

• Dematerialisation: All government securities are now issued and traded in electronic form.
• Primary Dealer System: Authorised institutions act as market makers to ensure liquidity and efficient price discovery.
• Retail Access: The RBI’s Retail Direct Scheme (2021) allows individuals to buy gilts directly, increasing financial inclusion.
• Integration with Global Systems: Enhanced transparency and participation through platforms like CCIL (Clearing Corporation of India Limited).
• Emergence of Gilt Funds: Mutual funds that invest primarily in government securities, enabling retail investors to benefit from professional management.