In the current landscape of escalating inflation, the prospect of securing long-term interest rates appears less prudent, while the allure of short-term rates as income generators remains lackluster. In such a scenario, investors seeking assured returns often turn to stalwarts like the Employee Provident Fund, Public Provident Fund, and Sukanya Samriddhi Yojana. Yet, these investments don’t offer immediate interest payouts; instead, they accumulate and mature over time, providing financial security for the future.
However, due to regulatory constraints dictating who can invest and the limits imposed on these schemes, investors find themselves on the lookout for additional alternatives. This quest is particularly pronounced among conservative fixed-income investors in search of stable gains amid a high inflation environment. This is where the National Saving Certificate (NSC) and Floating Rate Savings Bonds (FRSB) come into play. Here’s a comprehensive rundown:
Security:
The NSC, facilitated by India Post, and the FRSB, issued by the Reserve Bank of India (RBI) on behalf of the Government of India, both hold the status of quasi-sovereign securities. These instruments boast minimal credit risk, making them an appealing choice for those aiming to enhance their earnings without endangering their principal investments.
Returns:
While the NSC offers a fixed 6.8 percent interest rate payable upon maturity, the FRSB provides a more enticing 7.15 percent interest rate paid semi-annually. The NSC’s interest rate is subject to quarterly reviews, much like other small savings schemes. Once locked in, the NSC’s interest rate remains unaltered until maturity, mirroring the consistency of time deposits. Notably, the FRSB’s interest rate is linked to that of the NSC, offering a 35 basis points premium over the NSC’s rate. This interdependence means that if the NSC’s interest rate increases, the FRSB’s rate follows suit, and vice versa.
These returns shine brightly in comparison to other alternatives with similar tenures. For instance, a five-year fixed deposit offered by the State Bank of India, the largest public sector bank, yields a mere 5.5 percent. Target maturity funds (TMFs) featuring around five years of residual maturity present an indicative yield to maturity ranging from 6.45 to 6.65 percent. However, it’s important to note that debt funds, by law, do not guarantee returns and certain TMFs carry more credit risk than their sovereign-backed counterparts.
Tenure:
The NSC matures in five years, while the FRSB matures in seven years. Yet, the FRSB extends an early redemption option to senior citizens. Those between the ages of 60 and 70 face a six-year lock-in period, whereas individuals aged 70 to 80 contend with a five-year lock-in period. For those above 80, the lock-in period decreases to four years from the date of issue. Unlike the NSC, the FRSB cannot be leveraged as collateral for obtaining loans.
Taxation:
Interest earned from the NSC and FRSB is taxable for investors. However, investments in the NSC offer tax deduction benefits, allowing individuals to invest up to Rs 1.5 lakh for Section 80C tax deductions.
Investment Considerations: The suitability of both these instruments hinges on factors such as the prolonged lock-in period and limited liquidity. Mumbai-based Certified Financial Planner, Parul Maheshwari, advises, “Invest in these instruments only if you’re comfortable holding them until maturity.” Investors seeking intermittent cash flows might find the FRSB more attractive, as it provides interest payments semi-annually, unlike the NSC, which pays upon maturity.
High-tax bracket investors should also factor in pre-tax yields since the interest is taxable. Individuals in tax brackets of 30 percent and higher might find tax-free bonds more enticing, offering around a 4.5 percent yield and improved liquidity due to their presence in the stock exchange.
In the current climate of inflation, the flexibility of the FRSB’s floating rates may entice fixed-income investors. However, a word of caution: the FRSB’s interest rates have remained unchanged since their launch in July 2020, leaving uncertainty about future interest rate resets. Corporate Trainer in Debt, Joydeep Sen, remarks that while the government didn’t reduce interest rates on small savings schemes when general interest rates fell, it’s unlikely that NSC’s rates, which serve as a benchmark for the FRSB, will decrease in a rising rate environment.
Even if you’re comfortable holding the NSC or FRSB, it’s wise not to channel your entire fixed-income portfolio into them. Given the uncertainties surrounding inflation trends and interest rates, diversification is key. For medium-term exposure, these instruments can be valuable additions, serving as vital components within a well-structured portfolio.