Tax-free bonds for infrastructure, large investors

July 26, 2015 11:34 pm | Updated 11:34 pm IST

It is not for the first time that the government is allowing a few companies to raise funds through issuance of tax free bonds. The most recent permission given to seven central public sector enterprises (CPSEs), all engaged in crucial infrastructure activities, to collectively mop up Rs.40,000 crore is in line with the announcement made in the budget. Last year (2014-15) there were no such issues. So to an extent there would be a certain novelty factor this time.

The Central Board of Direct Taxes issued the notification on July 6. The intention is to enable these CPSEs to complete their fund raising exercise during the remaining 8 to 9 months of the year, The CPSEs, all big names in infrastructure are NHAI, IRFC, HUDCO, IREDA, REC, PFC and NTPC.

NHAI has been given the lion’s share, out of the total Rs.40,000 crore, it will mobilise Rs.24,000 crore (60 percent). IRFC will raise Rs.6,000 crore, HUDCO Rs.5000 crore, IREDA Rs.2,000 crore and the REC, PFC and NTPC Rs.1,000 crore each.

The rationale of this pattern of distribution is not clear. It is likely that what weighed with the government is the fact that CPSEs such as NTPC had access to equity and quasi equity in a way NHAI does not have as yet. That advantage, in turn, arises from the fact that NTPC and a few others had taken the long road to corporatisation earlier than the others.

It is also possible that investor perception of NHAI, what with the controversies over tolls and public private partnership in general, is not such as to attract many types of investors, Hence special sops, such as tax free status to their investors, will have to be given.

The government wants the CPSEs to go through the public issue route to an extent of 70 per cent, the balance to come from private placement.

Quite obviously from the overall perspective of public finance, the tax exempt bonds will be the exception and not the rule.

Will investors buy them?

That brings us to the other important dimension to the bond issues, their relevance as an investment option. The tax exempt status is their unique selling proposition but that cannot be the sole reason for investing in them. It goes without saying classes of investors, retail, high networth individuals (HNI), corporates, and others will view these bonds differently depending on their circumstances. The immediate point of comparison will be with fixed deposits with banks and companies, and to a lesser extent with the fixed maturity plans (FMPs) of mutual funds,

The government notification details the features of this series of bonds, their tenure, how much (tax-free) interest they can pay. The return on specific bond issues will vary depending on who is the investor and the rating obtained. The issuer with a higher credit rating can offer less. Retail investors can get more compared to other categories.

In all cases the interest rate will be subject to a ceiling on the coupon rates based on the reference G-sec rate. So in a way the tax-free bonds are linked to market rates and can move up and down with the G-sec rate.

It has been clarified that the interest rates referred to above are on an annual basis. Half yearly interest options, wherever offered, will yield less to the investor.

Advantages and disadvantages

Another reason these bonds will score over fixed deposits is that they have scope for capital appreciation. When interest rates fall the market value of these bonds will go up. The bonds should enjoy a fair amount of liquidity as they can be sold in the secondary market and because they have a high credit rating should enjoy investor confidence.

Unlike bank fixed deposits, tax free bonds have a longer tenure -10, 15 and 20 years. Investors can hope to avoid asset -liability mismatch by buying these bonds.

Despite so many attractive features the tax-free bonds will not appeal to all retail investors.

Contextually, interest rates are set to come down. The bonds to be issued will not offer the kind of interest previous issues offered. For retail investors the exit route is important, most of them will not be in a position to keep them till maturity, which at the minimum is 10 years.

Selling the bonds through the stock market is theoretically attractive but how many of the retail investors are savvy enough to take this route?

Interest payment once a year is definite disincentive. Most retail investors will prefer to receive interest at least once in three months.

For the pensioners and the salaried class about to retire, these bonds cannot be an option.

The above is not to deny the role tax free infrastructure bonds have in personal finance as much as in public finance.

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