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Understanding the Indian Fixed Income Market

Author Deepika Khude | Posted January 25, 2021

fixed income market

Who doesn’t love fixed income?

Most investors are always looking for fixed income products. Our love for ‘fixed income’ is why nearly 50% of Indians still invest in fixed deposits!

There’s nothing wrong with investing in fixed deposits. They are safe and perfect for low-risk investors.

But problem is our understanding of the term ‘fixed income’. Most investors believe that fixed income is equal to fixed deposits. But this is wrong.

Fixed income includes everything from treasury bills to corporate bonds. The fixed income market in India offers superior returns than bank deposits. Lack of knowledge is the reason why investors prefer savings accounts and bank deposits.

The aim of this article is to simplify the Fixed Income Market in India. We will cover the following…

  • What are fixed income securities?
  • What is the fixed income market in India?
  • How does the fixed income market work?
  • What types of securities are traded in the fixed income market?
  • Who are the key players in the Indian fixed income market?
  • Why Should retail investors invest in the fixed income market?
  • Who should invest in fixed income securities?
  • What are the risks involved in the fixed income market in India?
  • How can retail investors invest in the fixed income market in India?

What are Fixed Income Securities?

Fixed income securities are financial instruments that guarantee a ‘fixed income’. They carry a fixed rate of return and maturity period.

Fixed income securities are issued by both, government and private companies. They can be short term or long term. Fixed income securities maturing before 91 days are known as money market securities. Long term fixed income securities have maturity dates of up to 40 years!

Common examples of fixed income securities are:

Fixed Income Market Explained

Fixed income market is where fixed income investments are bought and sold.

In the fixed income market, investors provide loans to government and private companies. In return, investors get fixed income in the form of interest payments.

The Indian fixed income market is divided into 2 parts:

  • Primary fixed income market
  • Secondary fixed income market

In the primary market, fixed income securities are directly sold to investors. Example: RBI tax free Bonds, Sovereign Gold Bonds etc. are directly sold to investors.

Once issued, these fixed income products are traded i.e. bought and sold in the secondary market. Brokers help investors buy and sell fixed income securities in the secondary market.

The fixed income market in India is jointly regulated by RBI & SEBI.

Key players in the fixed income market

The fixed income market in India is mostly dominated by banks and other institutions. Retail investors’ participation is almost negligible.

Here’s a list of key players in the Indian fixed income market

  1. State & Central Government
  2. Municipal Corporations
  3. Public & Private Sector Banks
  4. Rural/Regional Banks
  5. Provident Funds
  6. Financial Institutions (NBFCs)
  7. Insurance Companies
  8. Mutual Funds
  9. Retail Investors

How Does the Fixed Income Market Work?

Let’s understand how the fixed income market works with this simple example.

Sita needed Rs 5 Lakhs to start a cupcake business. She approaches the bank for a loan. But banks are charging 12% interest!

Her friend, Gita offers to give her the Rs 5 Lakhs at 7% rate of interest.

The deal is simple: Sita will return the Rs 5 Lakhs after 3 years. Sita will also give a fixed yearly interest of Rs 35,000.

Sita got cheap finance while Gita got fixed interest & guaranteed return of capital.

Let’s substitute government or companies in place of Sita. This means government and private companies borrow money from investors. They pay fixed interest and repay the principal on maturity.

Type of Securities Traded in the Fixed Income Market

Two types of securities are traded in the fixed income market:

  1. Government Fixed Income Securities: These securities are issued by the government. Government borrows money for economic growth. The Indian fixed income market is dominated by government securities. They are safest as they are backed by the government of India.

Examples: Treasury bills, Certificates of Deposits, etc.

  1. Corporate Fixed Income Securities: Bond issued by private companies carry high credit risk. Companies borrow funds for growth and expansion.

Who should Invest in Fixed Income Securities?

There is no limit on who can invest in fixed income securities.

Ideally, fixed income securities are the best investment option for retirees and senior citizens. They provide guaranteed returns (principal repayment and interest payments). But retirees and senior citizens should stick to government bonds as they are safe.

Investors who want to diversify their equity portfolio can invest in corporate bonds. It offers higher returns than the G-secs.

Advantages of Investing in Fixed Income Securities

  1. Safety: Government securities are one of the safest investment options in India. Both principal repayment and interest payment is guaranteed by the government. G-secs carry zero default risk i.e. you will not lose your money.

While corporate securities carry risk, the risk can be managed by investing in AAA rated securities only.

  1. Superior Returns: Fixed income securities like NHAI, REC bonds etc. have given an average return of 6% – 7% in the last 10 years. The RBI tax free bond provides a return of 7.75%!

In comparison, the average 10-year return on Bank FD was only 4.5% – 5%. Hence fixed income securities are superior to bank deposits.

  1. High Liquidity: Fixed income securities with high credit ratings are highly liquid. They can be easily bought and sold on the secondary market. So, investors have an early exit option.
  2. Helps Save Tax: Government fixed income securities such as NHAI, REC bonds etc. help investors save long term capital gains tax u/s 54EC.
  3. Diversification: Fixed income securities are perfect to balance equity risk. Their guaranteed return helps in managing share market volatility.

Risks in the Fixed Income Market

While they provide high returns, fixed income securities are not Risk-Free.

  • Credit Risk: Credit risk is when the borrower is unable to repay the principal or pay interest. Default risk can be reduced by investing in only well reputed, top rated fixed income securities. Government securities carry zero default risk.
  • Liquidity Risk: Liquidity risk when you cannot sell an asset quickly. Government securities carry high liquidity but low quality bonds are highly illiquid.
  • Interest Rate Risks: Interest rate risk is when you lock in your funds at a lower interest rate. For example, Ram invested Rs 1 Lakh in 7.75% RBI Bonds for a tenure of 10 years. After a year, the interest rates increased to 8%. Now he will earn 0.25% less each year for the next 10 years.
  • Reinvestment Risk: Reinvestment risk arises on maturity. Assume after 10 years, Ram’s bond has matured. But the interest rates have fallen. He can reinvest at only 7%. The 0.75% loss between the old and new interest rate is his ‘reinvestment risk’.

How can Retail investors invest in the Fixed Income Market in India?

Retail investors participate in the fixed income market mostly through mutual funds. But sadly, mutual fund investments are only 0.70% of the daily fixed income market volume.

But with awareness retail investors have started investing in fixed income securities. Capital Gains Bonds are highly popular among retail investors for saving tax. Similarly, RBI 7.75% tax free bonds are popular among retirees and senior citizens.

The recent Sovereign Gold Bonds was popular among retail investors. They can invest in the fixed income market through:

The fixed income market in India is perfect for low-risk investors. It offers them higher returns with less risk. It is also perfect for individuals with huge equity exposure. Fixed income securities are win-win for low & high risk investors.

So, next time you think fixed income, you know better than to invest in just bank FDs!

By Deepika Khude

The author is a Certified Financial Planner (CFP) with 5 years experience in Investment Advisory and Financial Planning. Her strength lies in simplifying complex financial concepts with real life stories and analogies. Her goal is to make common retail investors financially smart and independent.

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