RBI's floating rate savings bonds: Good fixed-income option?

Fixed-income investors, get ready to pop the champagne! The RBI Floating Rate Savings Bonds 2020 (Taxable), also known as FRSBs, is now a click away from your investment portfolio, thanks to the RBI-Retail Direct portal.

This government-led online platform, launched by the Reserve Bank of India (RBI), is designed to streamline your government security investments.

What makes this bond interesting?

Picture this: an alluring 8.05 per cent interest rate on these bonds, a number that's hard to find these days. That too in a landscape where only the Sukanya Samriddhi Yojana (SSY) and the Senior Citizens' Savings Scheme (SCSS) dare to breach the 8 per cent mark.

But there's a catch - the SCSS is a seniors-only party, and the SSY focuses on nurturing a brighter future for girl children.

So, where does that leave the rest of the investor population hungry for hearty returns? Enter FRSBs, the investment that fills that void beautifully. That said, the interest you earn is taxable. Therefore, the post-tax interest rate will be lower for all investors in the higher tax bracket.

Is it wise to invest in them?

These are floating-rate bonds, meaning when interest rates are high, their yields are high, too. But when rates come down, so do their yields.

Given their background, we'd like to highlight that we may have reached the interest rate peak, as the Federal Reserve has maintained the status quo in its last two meetings. So, it is very much possible that the interest rates may not climb any higher.

And here's where 'floating rate' bonds can be risky. The 8.05 per cent returns you see today might not stick around in future. In fact, there could be a possibility of future reductions.

Therefore, opting for a fixed-rate investment could be a safer bet, ensuring that you lock in the current high rates without the unpredictability of the floating rates that come with FRSBs.

Is it all bad?

No, FSRBs do have an ace up their sleeve. They come with a clever little mechanism that promises they'll always be 0.35 per cent ahead of the National Savings Certificate (NSC) .

Since the NSC rates are evaluated every quarter, any increase in NSC rates directly benefits FRSB holders with higher returns. On the flip side, should NSC rates decrease, FRSB interest rates would similarly decrease.

That said, NSC rates are pretty steady and stable. They fall less compared to fixed deposits or bank deposits.

Since its inception, the lowest interest rate offered by NSC was 6.80 per cent, that too during the COVID phase. If you do the math, you'll find FRSBs never fell less than 7.15 per cent.

This maintains the appeal of FRSBs as an investment option despite potential fluctuations.

The bottom line

If you're the type to seek assurance and minimal risk, FRSBs could indeed merit your attention for the fixed-income part of your portfolio. They also come with the advantage of no upper limit on how much you can invest. However, do note that their post-tax returns will be lower, especially if you are in the 20 or 30 per cent tax bracket.

Finally, even though these bonds are subject to interest rate changes, there's a common belief that rates will likely hover above a respectable baseline, as the government tends to be conservative about reducing interest rates on small savings schemes, especially NSC, as shown above.

Also read: Should a retiree invest in RBI floating-rate bonds?

This article was originally published on November 07, 2023.