Why does the Government issue Bonds? What role does the RBI play?

Bonds are financial instruments issued by RBI on behalf of Central and State Government.

Why does it issue Bonds?

The Government uses the money raised from these Bonds in order to finance its Expenditure needs. Bonds are thus one of the most vital instruments to finance Government spending. Other ways being tax revenue from public/ Investments in PSUs, etc.

So, similar to how we as individuals bank with players such as State Bank, ICICI Bank, HDFC Bank, etc. - the same way, the Government banks through the Reserve Bank of India a.k.a. Central Bank.

How does the RBI auctions Bonds on behalf of Government?

Based on the yearly Budget presented by the Finance Minister during its Union Budget, the RBI lays out the Borrowing calendar. This calendar is intimated to Market participants on a half-yearly basis for GOI bonds. Based on that - a year round weekly auction of GOI & SDL Bonds takes place with a notified amount & tenor of securities that will be offered.

What is the frequency of Auctions?

GOI Bonds are auctioned every Friday.

Who participates in these Auctions?

Major Institutions such as Banks, Primary Dealers, RRBs, Co-operative Banks, Mutual Funds & Insurance houses participate in Auctions conducted by the RBI.

Recently, the RBI has allowed retail investors to also participate in these auctions via their RBI Retail Direct platform.

How are the Bonds allotted to Institutional investors?

The RBI determines the cut-off yield during this auction, at which Yield the Bond is priced at par (Rs. 100) - and which also becomes the Interest rate that the Bond gives to any investor in the Bond.

All bidders who bid better than the cut-off yield are then allotted the Bonds on a pro-rata basis.

In the next series, we will explore how the RBI determines cut-offs, and the various methods by which Bonds are allotted to Investors.

To read our previous articles, do read our write-ups here!