Government securities: are they safe?
How safe are government securities? Is this a question bothering you? Welcome. Many people have asked
me this question, and I have struggled to explain the answer.
Central Government securities are 100% safe. These are what are called ‘Soverign Paper’ and is guaranteed
by Pratibha Patil – the Government of India! Interest rate payments, principal, payments on the due date, or
on maturity are all guaranteed by the Government of India.
Are there risks? Yes there are risks associated with it:
a. Interest rate risk: If interest rate changes, price will change.
b. Inflation risk: the Government may be paying you 6.76% interest, if the inflation is averaging 9%,
you run an interest rate risk.
c. There is no call risk
d. There is not much liquidity risk in CG securities, but you may find liquidity risk in State Government
securities.
In government instruments like PPF you run a risk that the government may pay you in instalments. If you go on 2nd Dec 2014 to get your PPF encashed, it is possible that the government tells you “Please take Rs. 5lakhs now and the balance Rs. 12 lakhs will be paid to you in 12 annual instalments of Rs. 1 L each, with interest”
Has this happened in the past? Heck no. But any investment where the other person who is taking the
money can make the rules, you are at risk.
www.RaagVamdatt.com
Hi,
Apart from these, there is also a counter party (or default) risk.
This is the risk that the bond issuer would not be able to pay you the interest as promised or would not be able to repay your principal when it is due.
Of course, this risk is very minimal with government securities. Since the counterparty is the government, it can always print some money and give it to you if thats becessary!
However, there have been instances in the past (outside India) where soverign governments have defaulted on the debt issued by them. In fact, this is not very uncommon when it comes to debt issued to foreign investors.
BTW, I discovered your blog some days back, and I am hooked – I really enjoy reading it!
subra
Thanks! I promise to visit your blog! No with Central Government investments you do not have counter party (or default) risk. Please remember Governments have a lot of sources of revenue – agricultural tax, excise duty, service tax, etc. So it can never be short of revenue. Default is something you worry only about a foreign government. If you are sitting in USA, you worry about Indian government defaulting. If you are in India you do not worry about government default – by the time the gov defaults all other investments of yours would have already defaulted. If you have invested in say hdfc life insurance – please remember they invest in G-secs!
www.RaagVamdatt.com
Point taken – yes, domestic investors should not worry about their own Government’s default – only foreign investors should.
And “by the time the gov defaults all other investments of yours would have already defaulted” – can’t agree more!
As I mentioned earlier, even if other sources of revenue dry up, the government can always print its own currency and repay the investors.