Introduction
Floating Rate Savings Bonds (FRSB) have garnered attention as their interest rates are set to increase in July 2023. With historical returns serving as a guide, let’s explore the potential trends and whether these bonds can provide higher yields in the future.
It is possible that floating rate savings bonds (FRSBs) could offer higher yields in the future. This is because the interest rate on FRSBs is linked to the prevailing market interest rate. If market interest rates rise, then the interest rate on FRSBs will also rise. This means that investors who buy FRSBs now could potentially earn higher yields in the future if market interest rates rise.
However, it is important to note that there is no guarantee that market interest rates will rise in the future. If market interest rates fall, then the interest rate on FRSBs will also fall. This means that investors who buy FRSBs now could potentially earn lower yields in the future if market interest rates fall.
Overall, the decision of whether or not to invest in FRSBs is a complex one. Investors should carefully consider their investment goals and risk tolerance before making a decision.
The Floating Rate Savings Bond
The government introduced the Floating Rate Savings Bond in July 2020, offering an initial interest rate of 7.15 percent. These taxable bonds presently provide a 7.35 percent interest rate, with expectations of it rising to 8.05 percent later this year. The interest rates of these bonds are reset semi-annually, in line with the prevailing National Saving Certificate (NSC) rate, typically with a 35 basis points (bps) spread over the NSC rate. Following the recent increase in interest rates for small savings schemes, including NSC, to 7.70 percent, the rate on FRSBs is predicted to reach 8.05 percent by adding the 35 bps spread.
Features and Limitations: FRSBs are issued at a face value of Rs. 1,000 and multiples thereof. The interest rate is reset every six months, aligned with the coupon payment date. These bonds have no maximum investment limit but are subject to taxation under the Income-tax Act, 1961.
Tax will be deducted at source on interest payments, though exemptions are available for individuals providing a tax exemption declaration with supporting documents. Unlike some other bonds, FRSBs cannot be traded in the secondary market or used as collateral for loans. They have a maturity period of seven years, allowing premature encashment for investors aged 60 and above, subject to a minimum lock-in period of four to six years based on the investor’s age.
Future Rate Hikes
FRSB rates are linked to the NSC, which, in turn, is tied to government bond yields. The government has consistently aimed to prevent the decline of small savings scheme rates. In the latest announcement, the Centre revealed a significant increase in interest rates for the April-June 2023 quarter, with NSC witnessing the highest surge of 70 bps, reaching 7.70 percent. This adjustment corresponds to the upward trend in government bond yields. It’s important to note that bond yields are influenced by the overall state of the economy and inflation. Predicting future changes in inflation and interest rate movements remains challenging.
Expert Insights
According to Sriram Jayaraman, a SEBI-registered Investment adviser and Income tax planner, RBI floating rate bonds are a safe investment for individuals requiring income. However, he suggests that senior citizens first invest in the Senior Citizens Savings Scheme (SCSS), considering the increased limit of Rs. 30 lakh. Once this limit is reached, additional funds can be invested in RBI floating rate bonds. Jayaraman acknowledges that interest rates may decrease in the short term due to the declining trend in 10-year Gilt yield.
The Government’s Commitment: Despite fluctuations in government bond yields, the historical rates of NSC and other small savings schemes have remained unchanged or increased since June 2020. This can be attributed to the government’s commitment to maintaining attractive rates by adding spreads to prevent declines. If this trend persists, investors can expect higher yields from floating rate bonds in the future.
Here are some factors that investors should consider when deciding whether or not to invest in FRSBs:
- Their investment goals: Investors should consider their investment goals before investing in FRSBs. If investors are looking for a safe investment with a predictable income stream, then FRSBs may be a good option. However, if investors are looking for an investment with the potential to generate high returns, then FRSBs may not be the best option.
- Their risk tolerance: Investors should also consider their risk tolerance before investing in FRSBs. FRSBs are considered to be a relatively safe investment, but there is still some risk involved. If investors are not comfortable with any risk, then FRSBs may not be the best option.
- The current interest rate environment: Investors should also consider the current interest rate environment before investing in FRSBs. If market interest rates are low, then FRSBs may not be a good option. This is because the interest rate on FRSBs will be linked to the prevailing market interest rate. However, if market interest rates are high, then FRSBs may be a good option. This is because the interest rate on FRSBs will be higher than the prevailing market interest rate.
Overall, the decision of whether or not to invest in FRSBs is a complex one. Investors should carefully consider their investment goals, risk tolerance, and the current interest rate environment before making a decision.
Conclusion
Floating Rate Savings Bonds offer the potential for higher yields as interest rates are set to increase. While predicting inflation and interest rate movements remains challenging, historical trends indicate the government’s commitment to maintaining attractive rates. Investors should consider their financial goals, tax implications, and expert advice when assessing the suitability of these bonds in their investment portfolio.
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