Government Securities II

Mergers & acquisitions08 September 2015Government Securities IIGovernment Securities Act, 1996Overarching legislation permitting issue of government securitiesGovernment securityA security created and issued by the Government for the purpose of raising a public loan or for any other purpose as may be notified by the Government in the Official GazetteBond ledger accountAn account with the Bank or an agent in which the Government securities are held in dematerialised form at the credit of the holderSubsidiary general ledger accountThe account in which Government securities required to be held by banks are parked. Excess securities held may be traded out of this account. This account is held with the RBI

Government Securities Act, 1996Constituent subsidiary general ledger accountA segregated subsidiary general ledger account in which Government securities are held by banks, primary dealers etc. on behalf of their customers (who are referred to as gilt account holders)Interest and maturity proceeds are collected by the primary dealer and paid out to the gilt account holderReduces administrative burdens for the gilt account holderGovernment securities are held in the CSGL account in demat form, and only converted into physical form at the request of the gilt account holderGovernment Securities Act, 1996Limitation of liabilityWhere no shorter period of limitation is fixed by any law for the time being in force, the liability of the Government in respect of any interest payment due on a Government security shall terminate on the expiry of six years from the date on which the amount due by way of interest became payableProvided that the Government may allow a bona fide claim for payment of interest after the expiry of the period of six years in those cases where the holders of securities could not prefer their claims within the said period of six yearsGovernment Securities Act, 1996With respect to Government securities, permits:TransferNominationIssue of duplicate securitiesthe RBI to determine title to a Government security in case of disputeCreation of pledge over Government securitiesShut periodShut period means the period for which the securities can not be delivered. During the period under shut, no settlements/ delivery of the security concerned will be allowed. The main purpose of having a shut period is to facilitate servicing of the securities viz., finalizing the payment of coupon and redemption proceeds and to avoid any change in ownership of securities during this process. Currently the shut period for the securities held in SGL accounts is one day.

Whats the Risk?Government securities are generally referred to as risk free instruments as sovereigns are not expected to default on their payments.However, there are still a few risks involved.Market riskMarket risk arises out of adverse movement of prices of the securities that are held by an investor due to changes in interest rates. This will result in realizing a loss if the securities are sold at the adverse prices. Small investors, to some extent, can mitigate market risk by holding the bonds till maturity so that they can realize the yield at which the securities were actually bought.

Whats the Risk?Liquidity riskLiquidity risk refers to the inability of an investor to liquidate (sell) his holdings due to non availability of buyers for the security, i.e., no trading activity in that particular security. Due to illiquidity, the investor may need to sell at adverse prices in case of urgent funds requirement. However, in such cases, eligible investors can participate in market repo and borrow the money against the collateral of the securities.

Whats the Risk?Countries have at times escaped the real burden of some of their debt through inflation. This is not "default" in the usual sense because the debt is honored, albeit with currency of lesser real value. Sometimes governments devalue their currency. This can be done by printing more money to apply toward their own debts. Harder to quantify than an interest or capital default, this often is defined as an extraneous or procedural default (breach) of terms of the contracts or other instruments.

Whats the Risk?Today a government which defaults may be widely excluded from further credit, some of its overseas assets may be seized, and it may face political pressure from its own domestic bondholders to pay back its debt. Therefore, governments rarely default on the entire value of their debt. Instead, they often enter into negotiations with their bondholders to agree on a delay (debt restructuring) or partial reduction of their debt (a haircut or write-off).

Partial list of defaulting countries

GreeceIn 2012 investors lost 100 billion euros ($112 billion) in a huge debt restructuringInvestors typically accept higher yields on bonds maturing further into the future, judging the risk of owning them to be greater. In Greece right now, that relationship is inverted.2-year bonds are yielding 2.3% more than 10-year bonds.Since Greeces debt crisis began in 2010, most international banks and foreign investors have sold their Greek bonds and other holdings, so they are no longer vulnerable to what happens in Greece. Some private investors who subsequently plowed back into Greek bonds, betting on a comeback, regret that decision.

Greece

GreeceAlmost two-thirds of Greeces debt, about 200 billion euros, is owed to the eurozone bailout fund or other eurozone countries. Greece does not have to make any payments on that debt until 2023. The International Monetary Fund has proposed extending the grace period until mid-century.So while Greeces total debt is bigas much as double the countrys annual economic outputit might not matter much if the government did not need to make payments for decades to come. By the time the money came due, the Greek economy could have grown enough that the sum no longer seemed daunting.In the short term, though, Greece has a problem making payments due on loans from the International Monetary Fund and on bonds held by the European Central Bank. Those obligations amount to more than 24 billion euros through the middle of 2018, and it is unlikely that either institution would agree to long delays in repayment.Impact on Economic SovereigntyBefore buying a government's sovereign debt, investors determine the risk of the investment. The debt of some countries, such as the United States, is generally considered risk free, while the debt of emerging or developing countries carries greater risk. Investors have to consider the government's stability, how the government plans to repay the debt, and the possibility of the country going into default. In some ways, this risk analysis is similar to that performed with corporate debt, though with sovereign debt investors can sometimes be left significantly more exposed. Because the economic and political risks for sovereign debt outweigh debt from developed countries, the debt is often be given a rating below the safe AAA and AA status, and may be considered below investment grade.

Impact on Economic SovereigntyIndia is currently the lowest investment grade, rubbing shoulders with Turkey and IcelandIndia: BBB-Anything lower is considered not investment grade or a junk bondForeign investment in Government securities is considered by some to promote economic growth, yet destabilises economic sovereigntyBailouts from international finance institutions impose huge restrictions on governmentsThe IMFs bailout of Greece in 2010 has been conditional on acts such as reducing corruption, imposing austerity measures such as reducing non-profitable public sector services, raising tax revenueRestrictions could also include suggesting other forms of revenue raising such as nationalization of inept or corrupt but lucrative economic sectors.