Should you invest in RBI floating rate savings bond?

FOR conservative investors who are looking to generate decent interest income, RBI floating rate savings bond (RBI FRSBs) have gradually become attractive, but with a caveat.

The current interest rate on RBI FRSBs is 8.05 per cent per annum. The interest income is fully taxable and paid half-yearly on January1 and July 1 every year. There is no cumulative option in RBI FRSBs that pays out at the end of the tenure.

And how is the interest rate decided? There is a pre-approved and fixed formula for interest rate calculation on these FRSBs. It is pegged with the prevailing National Saving Certificate (NSC) rate with a spread of (+) 35 basis points or 0.35 per cent over the respective NSC rate. And the current NSC rates are 7.70 per cent. So, adding the +35 basis points spread, we get 8.05 per cent as the interest rate on RBI FRSBs.

What is important to note is that even though these bonds have a 7-year tenure, the interest rates of these bonds are not fixed (and hence the name ‘floating’) and are reset every 6 months based on the earlier-mentioned formula pegged to NSC rate changes.

So, at 8.05 per cent, are these RBI FRSBs worth investing in?

Just looking at the interest rate of more than 8 per cent, it definitely is attractive given the sovereign nature of these bonds that make it easy-risk-free 8.05 per cent as of now.

But let’s not forget that these ‘floating rate’ bonds and the interest rates are not fixed and instead, float. So, even though the bond tenure is 7 years, you may not get 8.05 per cent for the full tenure as bond rates don’t get locked for the entire duration. So, if the rate cycle turns and the NSC rates are revised lower, the FRSB rates will also adjust lower proportionately. Hence the decision to invest in FRSB should be taken based not just on the current rates but also on how the rates might change in the near future when the government revises NSC rates. Given that the NSC rates in the last 10 years have moved in the range of 6.80-8.50 per cent. So, FRSBs, which offer 0.35 per cent more than NSC rates, can also be expected to have a similar rangebound movement in the near future.

Also, one needs to look at other available alternatives when deciding about investing (or not) in RBI FRSBs.

For senior citizens, the Senior Citizen Savings Scheme (SCSS) offers a solid, guaranteed 8.2 per cent for the full tenure. So naturally, SCSS is better for senior citizens as a first choice.

Once that option is exhausted along with POMIS (and now-unavailable PMVVY), only then the FRSBs should be considered by seniors for incremental debt investments. As regards liquidity, a facility for premature exit is available only for senior citizens.

They can prematurely encash the bonds after the lock-in period of 4, 5, and 6 years in the age bracket of 80 years and above, between 70 to 80 years and 60 to 70 years respectively.

But for youngsters (below 60s), there are no high-interest options available that offer more than 8 per cent (not considering EPF as it is not available for everyone). So, it can be considered as an alternative to PPF, debt funds, etc. But do note since there is no cumulative option available for these bonds, it may not work well for those who are young and in the accumulation phase.

The current interest rate on RBI FRSBs is 8.05 pc per annum. The interest income is fully taxable and paid half-yearly on January1 and July 1 every year