Why RBI retail direct is not an attractive investment option for common man

The Reserve Bank of India’s latest offering for retail investors - investing in government securities - is likely to fall flat as returns from the scheme are much less attractive compared to other available options.

RBI Retail Direct Scheme, an investment option for retail investors was launched on Friday amid much fanfare by Prime Minister Narendra Modi. This scheme was described as a ‘significant milestone’ by the RBI in a statement, which also said that it would ‘bring G-secs within easy reach of the common man by simplifying the process of investment’.

Under the scheme, retail individual investors have to open a Retail Direct Gilt (RDG) Account with the RBI, via an online portal - (https://rbiretaildirect.org.in).

@RBI Says – a verified twitter handle of which describes itself as a public awareness initiative of RBI, tweeted to say that there was an ‘encouraging response’ to the retail direct scheme as over 12,000 registrations were made for the scheme till 2.30 pm on November 13.

Higher return from SSI

Small Savings Instruments (SSI) – the interest rate of which is set by the government - pose the biggest challenge to the scheme. The interest rates of SSIs are based on a formula, suggested by the Shyamala Gopinath Committee in 2016, which is linked to the yields of government securities. Although yields have hardened over the last six months, interest rates of the SSIs have been left unchanged.

In fact, for the last six quarters the interest rates have not been changed by the government.

The currently prevailing rates on various schemes range 47-178 bps higher than the formula-based rates for the third quarter (Oct-Dec) of the current financial year, the RBI’s monthly bulletin showed. Interest rate on one year term deposits of a SSI is higher by 178 bps, as compared to the formula-based interest rate suggested by Gopinath, a former deputy governor of RBI.

This makes SSIs far more attractive than directly investing in government securities.

“Based on safety, small savings instruments are just as safe as government security from a retail investor point of view,” said Dhirendra Kumar, chief executive officer, Value Research.

WATCH: Will RBI's Retail Direct scheme spur retail investor interest in bonds? 

One of the main concerns of the RBI retail direct scheme is liquidity. What if an investor wants to sell the security?

“They can sell it, but at what price? When you want to sell there should be a buyer. Who will be the buyer? We have to wait and see. It may come at a small discount. It entirely depends on the evolution in these bonds. Otherwise, it will become buy and hold security. For a hold to maturity investor, it is like a fixed deposit,” Kumar told Business Standard. Investments in government securities have no credit risk, as they enjoy a sovereign guarantee. The sovereign is expected to pay up as promised once the tenure of the bond is over.

Tax benefit

From a tax perspective, financial planners believe that coupon bearing bonds are not tax effective and investing in mutual funds is far more effective, as the effective tax rate is in single digits.

“There are several debt mutual funds that hold the underlying paper to maturity. If I am a retail investor, my objective is to hold the 10 year paper to maturity and get the yield. If there is a mutual fund which has a similar objective, is that not a better choice?,” said Suresh Sadagopan, a certified financial planner.

“Because the taxation is efficient beyond three years, for a bond fund, effective taxation comes to single digit, between 4-6%. The best part is that the liquidity is assured. You will get the money in 24 hours. It is better to invest through mutual funds,” Sadagopan added.

Rising interest rates

The retail direct scheme comes at a time when interest rates have bottomed out and are expected to go up. Yields have already hardened over the last few months. Bond prices and yields are inversely related.

The six-member monetary policy committee of the RBI has maintained status quo for the last 8 meetings. With the central bank already starting to unwind the excess liquidity, the next step would be to normalise the ultra-loose monetary policy stance which has been in force since the onset of the Coronavirus (Covid-19) pandemic. As there are pressures on inflation, with hardening of international crude oil prices, market participants expect the central bank to start raising the rates sometime during 2022. Yield will harden once the central bank starts raising interest rates and as a result, returns to bond holders will fall.