Government securities T-bills G-Sec

Government Bonds

Government raises money for its activities through various means. The bonds (debt instruments) are one way by which governments can finance its deficits. As in any investment, if the govt employs the capital in productive measures then the capital grows and if the spending is not done correctly the money raised is lost (value/ratings/yield etc of govt bonds reduces).

Government bonds are secure as the value is assured by the government. The rate of interest that government pays is determined by auction process. The rate of interest as in all cases is based on the credit risk.

What is credit rating of Indian govt bonds?

The credit rating companies (fitch, s&P etc) rate it based on various factors. The fitch rating is BBB- (2018 – 12 yrs it has been same).

The rating is based on many things like banking sector developments, shadow banking, deficit etc.

When the rating gets better, the credit will be available at lower rate of interest. More funds will flow ( higher risk = higher interest).

Content below may be read by people with interest in the subject, wont be asked in exams.

Who buys/takes/is bound to own/ Govt bonds?

The govt bonds are used to finance the govt activities and its deficits. It may be noted that banking, insurance sectors keep funds mandatory in Govt securities. This means when funds of citizens are parked in banks or when things (now a days everything is insured) get insured, the funds reach government. The pension funds too park money in govt securities.

Now, the govt bonds can be bought online through NSE and Zerodha buy individuals.

RBI through OMO (open market operations) purchases govt securities.

Why is it important?

The change in the international, national circumstances can lead to change in the government bond yields. The increase in deficit can lead to lower rating for the government bonds which means the credit becomes available for government at higher rate. When govt projects (huge ones) get locked without results then the capital doesn’t function effectively for its citizens and nation gets affected. Eg: Land acquisition litigations may delay a big road project causing huge cost escalations)

 

source: rbi reports

What are states doing?

The states too are increasingly borrowing to finance activities. There is significant growth over the years of SDL (govt securities sold by states) to raise funds.

The 2026-27 will be crucial looking at the maturity profile of SDLs ( state development loans). Also the way GST, discom debts , UDAY etc span out and is handled will be interesting for economic observers.

source: rbi reports

What to watch ?

Will the investors prefer buying the SDLs and moving them to Held to Maturity ?

click to enlarge, Source:ccil

Note: Persons who want to know more may read RBI reports on state finances. I have put up a very simplified gist of the subject. 

Middle Income Trap

It is a situation where a middle-income country is unable to become high income country as the situations for growth are slowing/ advantages which a country had is no longer present

Eg: A country has grown rapidly in industry due to cheap labour. As the country grew, the wages increased and hence the initial advantage of lower cheap labour diminished. Similarly, the manufacturing firms may shift to some country where the labour wages are lower than this country.

Hence, the GNP may get stagnated unless there is something the country does to overcome limitations. (commonly called reforms).

The reforms might be 1) Labour 2) Land 3) Capital/Investment etc

Challenges: If the administrative structure/information/expertise is lacking in recipient country, there may be unhealthy growth ( skewed distributing of income, cartelisation in businesses, plutocrats taking undue advantage)  .