The Hindu : US-64 redemption - Is the bond route viable?

Online edition of India's National Newspaper
Sunday, Mar 23, 2003

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US-64 redemption - Is the bond route viable?

By C. R. L. Narasimhan

The US-64 scheme, now segregated from the other schemes of the Unit Trust of India and put under an Administrator, enters a decisive phase in May. The Government's special repurchase scheme covering 5,000 units comes to an end. The unitholders have an opportunity to surrender 5,000 units at the special price of Rs.12 and the remaining units at Rs.10. The repurchase scheme, which has involved a guaranteed repurchase, has been a success as far at the UTI was concerned. It has helped in staving off redemption pressures during times when there was so much negative publicity about the scheme. If the perceptions on UTI have changed for the better since those dark days, it has been in no small measure due to the explicit support the Government has given.

The unitholders are now being given a choice: to invest in a new series of tax-free bonds or to encash their units at the agreed differential prices. Details of the new bond series have been communicated to all unitholders. Each bond, having a face value of Rs.100 and having tenure of five years, will yield 6.75 per cent payable half-yearly. The Government has guaranteed the bonds and the interest is exempt from incometax. The other attractive features are that it will be liquid: the bond can be transferred and is also expected to be traded from June onwards. All categories of unitholders can invest in the bonds. Clearly all the positive attributes have been designed with an explicit purpose of making the bond series a success. The Government has a huge stake. If a large number of unit holders opt for the tax-free bonds and not encash their units, the redemption pressures will be much less. In effect the liability to the unitholders gets deferred by five years, with the unitholders being given special incentives to opt for bonds instead of cash. Will the gambit succeed?

The UTI is going all out to sell the bonds. Certainly, the Government guarantee and the tax-free status enhance its appeal and even the interest rate of 6.75 per cent is in line with current levels. However, the decision to take the bond route will depend on a number of factors:

One, for individuals, a key determinant will be their tax status. The bonds are attractive for those in the highest tax slab (a pre-tax return of 9.64 per cent for those in the 30 per cent bracket).

For those in the lower slabs it is less attractive and for those not paying tax there is of course no special advantage beyond the absolute safety that the Government guarantee confers.

Two, corporate unit holders will look at the investment decision from an opportunity cost point of view. Is the locking in the maturity proceeds of the units in the tax-free bonds justified in relation to other uses for those funds including possibly in their own business areas? A decision like that cannot be taken lightly, given that so many parameters governing the macro economy are now in a flux. Have the interest rates bottomed out? Are the country's booming reserves sufficient to take care of the expected large oil import bill? Besides, the promise of liquidity will be a major factor influencing the decision.

Three, individual unitholders will have also have to reckon with other investment avenues. At present the opportunities for similar investments that deliver safe reasonable returns exist but only among other bond avenues.

In fact investors may be pardoned if they are confused over the several types of bonds the Government and the Reserve Bank of India are offering. However, the yields on all these are way below what the US-64 in its "hey-days" paid. As is well known, the US-64's main failing was that it kept paying high dividends even while it deployed a substantial portion of its corpus in equities.

The upshot was that it came to be regarded as a regular return scheme. Many individual investors, especially those in the non-tax category, will have to drastically reorient their mindset to invest in the bond scheme.

For the high taxpayers, however, the bonds are a good option.

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