RBI Floating Rate Bonds Are Safe, But Should You Invest?

Every investment carries some form of risk, but if one is looking for the safest investment, RBI floating rate bonds would surely be it, since they are backed by the Government. These bonds offer an interest rate that is 0.35 per cent higher than that of the National Savings Certificate (NSC). Currently, these bonds are offering an interest rate of 8.05 per cent. Further, they have a seven-year lock-in period and their interest rates are reset every six months. However, the lock-in periods are shorter for senior and super senior citizens.

Does it make sense to invest in them? Let us take a look.

The Interest Rate Risk
However, while these bonds carry no credit risk, there is interest rate risk.
There is a general expectation that interest rates will reduce. RBI and Central Banks across the globe sharply increased the rates to combat high inflation. With inflation now tapering down, banks are considering reducing rates as part of their monetary policy. While the interest rates might not come down this year, the next change in the interest rate is most likely to be a cut.
"As these are floating rate bonds, the applicable interest rate will change over the tenure of the bonds. Given that rates are possibly at their peak; investors should expect that RBI will subsequently revise these rates lower. This means that even if you are already holding these bonds, your interest will accordingly be reduced," says Nikhil Aggarwal, Founder and CEO, Grip Invest, an alternative investment platform.

Agrees Vishal Goenka, Co-Founder of IndiaBonds.com, an online bond platform "It is important to note the caveat of reduced liquidity and potentially declining pay outs in a falling interest rate environment. The suitability of these bonds ultimately depends on the investor's risk preferences and return objectives." 

Floating rate bonds are more suitable for investment when the interest rate cycle is at its bottom as investors get the benefit of any interest rate revisions. At the top of the interest rate cycle, it is more advisable to look for fixed rate bonds. "This could include fixed deposits (FDs) or even corporate bonds. Undoubtedly bonds issued by RBI can be considered to be risk-free and investors should select AA or AAA rated bonds to ensure they enjoy a similar risk cover," says Aggarwal.

Need A Regular Income? 
Any investment will either have appreciation or a regular income. RBI floating rate bonds pay interest semi-annually, hence they belong to the latter category. So, they make sense only if you need a regular income.

"If I do not need a regular income, I should not be looking at passive income as it dilutes my future growth, it adds to my taxation, it affects my liquidity and it is a wasteful expenditure," says says B. Srinivasan, director and founder, Shree Sidvin Investment Advisors. Hence, these bonds do not make sense if you are in the stage where you are looking to grow your wealth and build a corpus to meet long term goals.

Is It For Senior Citizens?
Senior citizens looking for secure investment avenues will find these bonds particularly appealing due to their zero-credit risk and regular interest payments, although the pay outs may vary with changes in the base rate.

"For example, if a senior citizen invests in these bonds at the current rate of 8.05 per cent and assuming a moderate decrease in rates by about 100 basis points in the future, the investment would still yield sufficiently, albeit slightly less, over time," says Goenka. 

This setup helps in preserving capital while providing a steady, if not entirely consistent, income stream in retirement.
The Final Word 

Also, one needs to keep in mind the tax aspect. Income from these bonds are taxed at applicable tax rates. "Human psychology plays a big role here. Someone may think that 8.05 per cent is a good rate of interest and so I am locking in now. But I need to know what I am locking in and whether it is essential or not," says Srinivasan. The real rate of return post taxes will be lower. 
So, these bonds make sense only for senior citizens who need a regular income, even though they are safe and are now offering 8 per cent interest.