Not reaching out

Special Report

 Rather than make a splash, government securities waded gently into the retail market; not surprisingly, it didn't create any ripples among investors either.  While they have made an entry only in the past few months, experts say there a host of problems dogging the market, and this is likely to keep a lid on investor response.

 <b>Problems and more problems</b>

 It's frustrated debt experts, who argue the government should be doing more to spread the word about the benefits of investing in government securities. "The main reasons for the low response from individuals has been a lack of awareness of government securities and the limited geographical reach for availability of the same," says Arun Kaul, managing director, PNB Gilts.

 Indeed, caught up with the usual sound and hoopla that accompanies equities and mutual fund investing, ordinary investors have looked past government securities. Experts say that there are many fences to cross before gilts can win a place in the minds of investors. Government securities, or gilts, are debt instruments issued by the government. They promise periodic interest payments, can range between one and 25 years and considered virtually free from the risk of default.

 And those are alluring qualities. "Indian investors still look for assured returns," says G V Nageswara Rao, managing director, IDBI Capital Market Services. Yet attempts to warm up to investors have been hemmed in by variety of reasons. "The popularity will spread, but it will happen very slowly," says Sudhir Joshi, treasurer at HDFC Bank.

 While government securities are the most widely traded debt market -- accounting for over 95 per cent of volumes in the secondary debt market -- they remain overwhelmingly the turf of wholesale buyers and sellers, which includes banks, financial institutions and primary dealers.

 On average, trading volumes in the retail market cluster around Rs 3,500 crore. That's compared with over Rs 20,000 crore generated in trading in the wholesale market - every week. Even in the retail market, pension funds and provident funds make up around 85 per cent of investors, while ordinary individuals account for a measly 3-5 per cent.

 <b>Can't see, can't hear</b>

 One of the key factors keeping gilts in the slow lane is that it's still very difficult for retail shoppers to lay their hands on gilts.

 Unlike stocks and bonds and mutual fund schemes that are sold by hundreds of brokers and agents across the country, there are very few retailers dealing in government securities. Even now, only a handful remain noteworthy --PNB Gilts and IDBI Capital Market Services. PNB Gilts, for example, has tied up with 26 branches of Punjab National Bank, and some of its own offices in the metro cities also offer gilts. There's also some criticism about the lack of aggressive promotion.

 HDFC Bank's Joshi says that unless the government turns up the volume on promoting gilts, the response is likely to stay muted. "The players are not going to spend themselves on promoting gilts," he says.

 <b>Few arguments to buy</b>

 Too few tax breaks also weaken the argument for investing in these instruments (refer box  "Know your gilts" ) . "The benefits of Section 88 should be extended to government securities," says ICMS's Rao.

 Section 88 of the Income Tax Act allows for different levels of tax rebates, depending on the type and amount of investment and total taxable income. It's a driver in drumming up support for small-savings schemes including the public provident fund. "Fiscal incentives can be a powerful measure to focus attention on gilts," Rao says.

 HDFC Bank's Joshi also argues for more benefits to be packed into the purchase of gilts.  "People invest for any of these three basic reasons: to get fixed returns, to make gains or to save tax," he says. And gilts, most believe, offer very little in the way of satisfying at least two of those needs.

 <b>..And no  arguments to sell</b>

 In addition, a lack of dangling carrots leaves sellers less inclined to waste energy on peddling gilts to retail clients. That's because the Reserve Bank of India (RBI) offers no commission to sell its most widely traded wholesale instrument to retail clients. That's in stark contrast to the sale of instruments such as the RBI Relief Bond, says PNB's Kaul, for which the RBI pays a commission of 0.5-1 per cent.

 <b>Interest rate turmoil</b>

 If these weren't bad enough, events of the past year didn't do much to help either. A hail of interest rate cuts have dealt concussive blows to yields on fixed-income securities; gilts were no exception.

 "During the past year, yields on government securities have fallen by about 300 basis points, making the return on government securities lower than those on banks fixed deposits," says PNB's Kaul. 

 "With a variety of attractive investment options like RBI Relief Bonds, mutual funds, and bank fixed deposits, interest and investments in g-secs were lower."

 A key reason why investors remain far from convinced about the merits of gilt investing. Indeed, gilts have been standing head-to-head in competition with gilt funds. Gilt funds are mutual funds that stock up their portfolios with government securities of various maturities. And so far the balance has tipped quite heavily in favour of gilt funds. Indeed, gilts funds have had an extremely enviable 2001.

 While investors of fixed-income securities agonised over the rate cuts, gilt fund managers turned them into extremely profitable events. With plenty of opportunities to trade in gilts, they delivered returns that sizzled at 25-30 per cent, making gilt funds the star investment of the year.

 Besides, till recently, returns on gilt funds also had the extra sheen of being completely tax-free in the hands of the investor. However, with those returns now shorn of their tax-free status, "there is a possibility of gilt funds losing the investors' attraction to some extent," points out PNB's Kaul.

 <b>The redeeming quality</b>

 And the enthusiasts insist that gilts have one feature that no other avenue possesses: longevity. Gilts are the only instrument on the Indian investment scene that investors can cling to for a decade or more and still earn a fixed income. 

 "There is no other instrument that can give you fixed returns for such a large period," agrees HDFC Bank's Joshi.Despite all the evidence indicating fractured support, most debt experts are convinced that gilts remain an appealing proposition and holds hope for the future.

 Still, unless the flaws are removed, ordinary investors are unlikely to stray from more conventional forms of investment to gilts. Until then, change will be slow in coming.

 <b>KNOW YOUR GILTS</b>

 <b>Price:</b> The price at which the security  sells in the market

 <b>Coupon rate:</b> The rate of interest offered by the issuer

 <b>Coupon interval:</b> The period after which interest on the instrument is to be paid (annual, semi-annual, quarterly, monthly)

 <b>Face value:</b> The value on which the coupon interest is computed

 <b>Redemption date:</b> The date of maturity on which face value is redeemed

 <b>Yield to maturity:</b> The discount rate at which coupon cash flows equate to the price of the bond. This is the market rate of interest which changes frequently and is distinctly different from the coupon rate

 <b>Tax treatment:</b> No Tax deduction at source. Additional rebate of Rs 3000 available to individuals under section 80L of the Income Tax Act. When traded in the secondary market, any gain/loss in such transactions will be taxed as normal capital gain/loss.