Treasury Bills

Introduction

The pandemic has had multiple repercussions on the worldwide financial markets. There is increased volatility and uncertainty, especially for equity instruments. There is a shift in investor mindset from unpredictability to safety. In India, the fixed-income market is niche and relatively unexplored. Fixed-income securities include fixed deposits, bonds, debentures, commercial paper, treasury bills, and corporate deposits. 

How to invest in T Bills?

The Government of India and the Reserve Bank of India issue treasury bills. It is a promissory note that guarantees repayment at a future date. The government utilizes proceeds from treasury bills to meet its short-term liquidity requirements. Thus, government treasury bills help reduce the country's overall fiscal deficit.

Treasury bills are money market instruments with short-term maturity. The maximum tenure of treasury bills is 364 days. Typically, treasury securities are zero coupon rate investments.  The government issues treasury bills at a discount, i.e., at a rate lower than its nominal value. Individuals can purchase government treasury bills at a discount and redeem them at a nominal value. The difference between the purchase and sell price is the return on investment.
 

Why Does the Government Issue Treasury Bills?

In India, treasury bills are issued by the Central Bank. The primary objective of treasury bills is as follows.

A.    Raise Capital 
Treasury bills help the government to raise funds for its current obligations. Treasury bills are especially useful if annual revenue generation is less than short-term commitments. When you purchase a Treasury Bill, you effectively lend the government money. In turn, the government utilizes the proceeds to pay recurring expenses such as salaries or military equipment. It may also use T-bills to finance its debt.  
 
B.    Regulate Currency Circulation
The Reserve Bank of India also uses treasury bills for its open market operations to control the liquidity and inflation in the economy. When the central bank perceives excess money in the economy, it sells treasury bills to investors to wipe off the surplus funds and vice versa.

Similarly, The Reserve Bank issues high-value treasury bills through economic booms to restrict liquidity and the aggregate money supply in the economy. In effect, it controls the demand in the economy and high prices. Therefore, T-bills allow the government to keep inflation under control.

Conversely, RBI uses a contractionary policy for economic slowdown and recession. It reduces the circulation of T-bills or the discounted value of bonds. Effectively, it discourages investors from channelling resources toward government securities and boosts cash flow in other industries. Therefore, it creates demand and improves the GDP of the nation.
 

Types of Treasury Bill

The differentiation factor for treasury bills is the tenure of the security. In India, there are four types of treasury bills. The T-bill rates are also reliant on these tenures. These include:

●    14-day treasury bill
●    91-day treasury bill
●    182-day treasury bill
●    364-day treasury bill

While the face value and discount T-bill rates change periodically, the holding period remains constant. The nominal value and market value change per the capital requirement and monetary policy of the Central Bank.
 

Features of Treasury Bills

1.    Minimum Investment 
The minimum investment required for treasury bills in India is Rs. 25,000. The additional investment must be in multiples of Rs. 25,000.
 
2.    Zero-Coupon Bonds
Treasury bills are zero-coupon bonds, and investors do not earn interest or coupons on the principal investment. The Reserve Banks sell treasury bills at a discount to the face value. On redemption, the investor obtains the entire face value of the bill. Thus, the return earned is by way of capital appreciation.
 
3.    Investment Yield
The yield generated from a treasury bill is as below:

Yield = (100-P)/P * 365/D * 100 

where,

P indicates the discounted or purchase price of the T-bill and
D refers to the tenure of the bill

Suppose a 91-day treasury bill with a face value of Rs. 100 trades at Rs. 98.

The yield is (100 – 98)/98 * 365/91 * 100 = 8.19%
 
4.    Investment Mechanism
The investment mechanism for treasury bills is unique and essential for investors. Every Wednesday, the Reserve Bank auctions treasury bills in the market on behalf of the government. The quantum of securities auctioned depends on bids placed on major stock exchanges. Investors may invest in treasury bills through commercial banks, depository participants, or primary dealers. The settlement period is T+1 for such cases.

Alternatively, individuals may invest in open-ended mutual funds that deal primarily in treasury bills and government securities.  

5.    Risk Involved
The risk involved in treasury bills is minimal. An investor incurs a loss only if the government defaults on repayment. Therefore, T-bills are mainly subject to default risk by the government.  
 

Advantages of Government Treasury Bills

1.    Liquidity
Governments use treasury bills for short-term capital requirements. The maximum tenure of a T-bill is 364 days. Therefore, individuals with a short-term investment horizon prefer to invest in treasury bills. Treasury bills trade in secondary markets. Investment can liquidate the securities in case of an emergency. 
 
2.    Price Discovery 
The Central Bank offers T-bills through a non-competitive auction every week. It allows retail and small-scale investors to participate in the bids without quoting the yield or price. Novice investors can access the treasury bill market too. It creates more liquidity and cash flow in the market.
 
3.    Fixed Returns
Treasury Bills yield a fixed return. An investor is aware of the absolute return before investment. Thus, it enables investors to make an informed decision and effectively analyze the cost-benefit tradeoff.
 
4.    Risk-free
Treasury bills are a liability for the Indian Government and the Reserve Bank. The government of India is responsible for repaying the investment within the stipulated time. Investors enjoy maximum safety on the funds invested. The highest authority in the country backs the investment. The government must repay the security even in an economic crisis.
 

Limitations of Treasury Bill

The basic rule of finance is risk and return are directly proportional. T-bills are low-risk investments, so the return is also comparatively less. Return from equity instruments is significantly more than T-bills.

For T-bills, the return on investment is constant irrespective of the economic condition or business lifecycle fluctuations. In contrast, market variations strongly influence returns generated by equity and debt instruments. In case of a sudden upswing, the income from other instruments tends to be phenomenally higher than capital gains from government securities.
 

Taxation

The holding period for treasury bill investment is short-term. Also, the revenue earned is in the form of capital appreciation. The returns are constant, and there is no scope to incur a loss. Therefore, revenue from treasury bills is subject to short-term capital gain tax.

The income tax rate for short-term capital gain depends on the investor's income tax slab. However, one of the major advantages of government securities is the non-applicability of tax deducted at source (TDS). Retail investors need not pay any TDS on the redemption of bonds. Thus, it reduces the hassle of compliance and related intricacies.
 

Who Should Consider Investing in Treasury Bills?

Treasury bills are a suitable investment alternative for individuals with surplus funds who expect substantial returns from a secure investment. Retail, high net-worth, and institutional investors can invest in treasury bills through a transparent investment process. The auction process for treasury bills is inclusive and allows equal opportunity for each investor type.

Treasury bills are ideal for the following investors –

●    Risk-averse investors – Investors who prefer to avoid the equity markets or have a low-risk appetite prefer T-bills. Investment in government securities is risk-free.
 
●    Experienced Investors – Even experienced investors turn to treasury bills as a diversification tool. Treasury bills help to offset the risk involved with volatile instruments.
 
●    Beginners – Treasury bills are easy to understand and not too complex. The investor has sufficient details about returns on investment. Therefore, beginners or novice investors prefer straightforward instruments such as treasury bills.
 
●    Short-term Investors – Investors with an ultra-short-term or short-time time horizon prefer to invest in treasury bills. The tenor for investment begins with 91 days. Therefore, short-term investors prefer risk-free treasury bills over fixed deposits with commercial banks.
 
●    Limited Capital Investors – The minimum investment amount for treasury bills is marginal. Therefore, even investors with limited capital can invest in treasury bills.
 

Bottom Line

Sovereign bills play a critical role in regulating the money supply, liquidity in the capital market, and boosting the economy. For an investor, treasury bills help in financial planning and wealth accumulation. Although relatively unexplored, treasury bills have multiple benefits and applications.