Allow small savers into gilts

Ask money managers what they would bet their shirt on today and they wax eloquent about the Indian government bond. With the ten-year gilt offering a yield of close to 9 per cent, foreign institutional investors, domestic mutual funds and pension funds have been making a beeline for this instrument. The prospect of pocketing a neat capital gain on these bonds if interest rates tumble from here only adds to their allure.

Yet, can you think of even a single retail investor who owns this cast-iron investment? Not likely.

Though the government securities market has been theoretically ‘open’ to small investors for some time now, hardly any of them are aware that they can actually participate in it. The few who have tried are likely to have been stonewalled by problems of access or liquidity.

It is difficult to miss the irony in this situation. For a long time, policymakers have been trying every trick in the book to lure retail investors into financial instruments.

But these efforts, for some strange reason, have centred mainly on getting retail investors to buy stocks.

Thus, initial public offers (IPOs) have a retail ‘quota’ to enable greater small investor participation. Follow-on offers by government companies usually throw in a ‘retail discount’ of 5 per cent. Mutual funds and brokers are trying hard to promote the convoluted Rajiv Gandhi Equity Savings Scheme, which offers first-time equity investors a tax sop to buy shares.

And to top it all, while you cough up taxes at 10-30 per cent on the interest from debt instruments, equities enjoy the most favourable tax treatment — you pay no capital gains tax after one year, even if you make manifold gains.

But tax breaks or no tax breaks, retail investors are now unwilling to bet on equities because they mortally fear the volatility that comes with this asset class. And who can blame them? From the time the market last peaked out in 2008, the Sensex has taken five years to get back to its starting point.

During this journey, some stocks have lost as much as 95 per cent of their original value, never to recoup it. Even good equity funds have lost 50-55 per cent in a single year before clawing back.

As to IPOs, their track record is far worse than secondary market investments. The BSE IPO index shows that an investor who put money in every IPO between August 2009 (when the index was launched) and now has suffered a capital erosion of about 30 per cent till date. An investment in the Sensex in August 2009 would have by now grown 33 per cent.

And it is a moot point how much of the retail money channelled into IPOs has really been used ‘productively’ to rev up the economy — put up manufacturing units, generate employment and all the rest. A portion, certainly, has lined the pockets of unscrupulous promoters.

The short point is that it is futile, even flawed, to use quotas and tax sops to lure a first-time investor to try his luck with IPOs or stocks. If he doesn’t have the ability to select the right businesses or the risk appetite to handle violent swings in stock prices, who is to compensate him for the resulting loss of capital?

If the idea is simply to channel household savings into financial markets so that they can be productively used, this can be quite effectively done through bonds.

A government bond that raises money for public projects or an infrastructure bond raised by a power or housing company does a much better job of routing household money directly into industry, than does an IPO.

Then, there is the matter of access. Think about how easy it is for retail investors to buy the most risky financial instruments today.

Initial public offers from start-ups, penny stocks, non-convertible debentures from gold loan NBFCs, fixed deposits from realty companies — all these instruments can be bought by a retail investor at the click of a mouse.

Most private banks and stock brokers offer online platforms that allow you to transact easily on these instruments. Yet, hardly any retail investor would even know the first thing about buying the safest instrument of them all, the government bond.

Though the Reserve Bank of India has done elaborate studies and presented powerful arguments on the need to open up the Indian gilt market to retail investors, investing in gilts still entails cumbersome procedures that retail investors are unlikely to go through.

Most retail investments today happen through financial advisors or distributors who physically visit the investor or through online platforms offered by banks and stock brokers. But government bonds can be bought through neither of these channels.

To buy a government bond, a retail investor needs to apply to a Primary Dealer — one of a select set of banks — and complete Know-Your-Customer formalities. He then needs to open a gilt account that links to a demat account and wait for his orders to be conveyed and matched by the primary dealer.

Of the long list of primary dealers who do operate in the gilt markets, only IDBI Bank has made a special effort to simplify government bond access to retail investors by opening a retail portal. But for anyone who is used to the transparency and seamless transaction and settlement processes of the equity markets, trading in government bonds can still be quite a hassle. As most trades in this market are put through by giant institutions, buying and liquidating small lots is a problem.

Unless government bonds are made as easy to access as, say, the Public Provident Fund or stocks, retail participation in this market is likely to remain abysmal. Pushing large online trading platforms to offer government bonds on their menu and providing a market-making mechanism to retail investors for better liquidity should help a great deal in popularising gilts.

But given that government bonds cannot carry interest rates of 11-12 per cent offered by some private issuers or company deposits, and will be locked in for the long-term, will they find takers at all? Well, the overwhelming response to recent tax-free bond issues from quasi-government issuers such as NTPC and Power Finance Corporation shows that they will.

If there is any lesson at all to be learnt from the various financial market scams of the last three years, it is that Indian small savers value fixed returns above everything else.

They aren’t evaluating a so-called Saradha ‘deposit’ or a Sahara ‘bond’ for the issuer’s creditworthiness or credentials. They aren’t even looking too keenly into the financials of a realty company or an NBFC to see if it can service a deposit. All they want is a predictable post-tax return that keeps pace with inflation.

That is exactly what the recent tranche of tax-free bonds have delivered — a sovereign guarantee, returns of 8.8-9 per cent and tax breaks that make sure the returns flow in full to the investor. If that is provided, even a 10-20-year lock-in period and uncertain liquidity aren’t deterrents. But these tax-free bonds are available mainly to high net worth investors.

So policymakers should probably forget about equities for a while and focus their efforts instead on democratising the government bond market.

Who knows, if first-time investors end up pocketing hefty gains from the 10-year gilt, they may even develop the risk appetite to try out the gut-wrenching ride offered by equities.