One instrument worth considering in this scenario is the RBI Floating Rate Savings Bond (FRSB), which currently offers 8.05% per annum and comes with the comfort of sovereign credit quality.
How does it work?
The FRSB is issued by the RBI on behalf of the government of India. You don’t need a demat account to invest; you can buy it from a bank or the RBI’s Retail Direct platform.
Its interest rate is linked to the National Savings Certificate (NSC) rate, with an additional 0.35% spread. The NSC currently offers 7.7%, pegging the FRSB’s interest rate at 8.05%. The rate is reset every six months, depending on changes in the NSC rate, though the 0.35% spread remains fixed.
Historically, the NSC has not seen steep cuts, and the lowest FRSB coupon since launch has been 7.15%. As Vidya Bala, co-founder of Primeinvestor.in, said, “Although it is a floating-rate instrument, the rates have largely remained reasonable, even in times when interest rates have fallen.”
Interest is paid semi-annually. For example, on a ₹10 lakh investment at current rates, you’d receive a half-yearly payout of ₹40,250, which would total about ₹5.63 lakh over the seven-year lock-in. The payouts are made on 1 January and 1 July every year.
What about liquidity?
FRSBs come with a seven-year lock-in, with no option to trade or pledge them as collateral to raise funds. This limits liquidity compared to bank fixed deposits, which can be withdrawn prematurely, albeit with a penalty.
Ankit Gupta, co-founder of BondsIndia.com, said as FSRBs are not a tradeable security like other bonds, investors cannot sell them on any exchange or exit during the lock-in period. The minimum investment is ₹1,000, with no upper limit.
Senior citizens, however, get preferential treatment with shorter lock-in periods. Investors aged 60 to 70 years have a six-year lock-in, those between 70 and 80 have a five-year lock-in, and those above 80 are required to stay invested for only four years. Senior citizens can also exit prematurely by forfeiting half of the last interest payout.
Remember, rates can change
As it is a floating-rate instrument, FRSB’s interest rate may change in the future. “It is a floating-rate bond, which means the rate may be reduced if the NSC’s rate is reduced. At some point, if the rate-cut cycle restarts, there could be an impact on small savings schemes such as NSC, too,” Gupta said.
“Unlike bank FDs where you can lock in an interest rate for the long term, a floating-rate bond may be susceptible to interest-rate changes over its lock-in period,” he added.
But as mentioned earlier, the government has generally been conservative when cutting rates on small savings schemes like NSC. Since its launch five year ago the FRSB has only seen two rate changes – both increases, following NSC rate hikes. NSC rates haven’t been cut recently, despite recent interest rate cuts by the RBI. And if interest rates are hiked and government decides to increase the NSC rate, FRSB will see higher rates, too.
However, there is no cumulative option on the bond, meaning interest won’t compound over the holding period. It is up to the investor to reinvest interest payouts in FRSB or other debt instruments to create a compounding effect.
How is it taxed?
Interest earned on the bond is fully taxable at the investor’s income slab rate. If annual interest exceeds ₹10,000, it is subject to 10% tax deducted at source (TDS). This makes the instrument more beneficial for those in lower tax brackets. For instance, an investor in the 5% slab effectively earns a post-tax yield of 7.63%, while someone in the 30% slab ends up with 5.54%.The principal (original investment) is returned tax-free at the end of the seven-year lock-in period.
Even then, the yield remains competitive when compared with those of bank deposits, where five-year tenures currently pay slightly over 6% pre-tax. State Bank of India offers 6.05% on fixed deposits of more than five years.
Should you invest?
The FRSB comes with the safety of sovereign backing and currently offers an attractive interest rate. It can be used to improve your portfolio’s overall yield, but needs to be combined with other debt products to address the liquidity constraints.
“Investors who need liquidity should still consider products such as bank FDs, which can be withdrawn before maturity, although with a penalty. The floating-rate bond can be combined with more liquid investments to optimise the overall yield. On the other hand, investors who don’t need immediate liquidity can consider making larger allocation to FRSB,” said Joydeep Sen, corporate trainer and author.
FRSBs can also work well for investors seeking a regular income through interest payouts. But remember, the payouts may vary if the NSC rate changes.