Climb up the Rate Ladder with Tax-Free Bonds

Dual Benefit of Fixed Return plus tax-free return

Loans have become dearer!  Banks and housing finance companies have upped their base rates on the back of firm bond yields. 

But that’s just one side of the story. 

As an investor, you can tap this opportunity to earn more from these high yielding bonds. 

Bonds give you stability and a fixed return amid choppy markets. Interest income is tax exempt in case of tax-free bonds. That’s like an icing on the cake. 

The government has permitted 13 PSU companies to issue tax-free bonds. A spate of bond issues will hit the market beginning tomorrow. REC Tax-free bonds issue opens for subscription on 30th August, 2013.

How are these bonds priced?

These bonds will be benchmarked to the 10-year Government Security, which is currently trading in the range of 8.5-9%. The PSU companies will announce the coupon rate of the tax-free bonds in days to come. However, analysts are expecting the tax-free bonds to fetch a rate of 8-8.5%.

Secondly, 40% of the issue will be for reserved for retail investors. The tenure of these bonds typically ranges from 5-20 years. However, check if the bonds have the call or put options, which gives the issuing company a right to call back bonds for redemption or even you can redeem the bonds at an early stage. 

As the name suggests, the interest income on these bonds are exempt from tax. 

Are they worth your buck?

1) Lock into high rates

There has been a speculation that rates will come down even as rates have actually been heading north past few days. If the rupee and other macro fundamentals co-operate, the rates will come down in future so as to put India Growth story on track. This simply means, you get an opportunity to lock into high rates through these bonds now. 

2) Rating Matters

Play safe in the current environment. Bond investments are low risk in nature. But 10-year period is very long. Hence you should opt for well-rated instruments. Each of these bond issue is rated by an external credit rating agency such as ICRA, CARE Ratings, S&P Crisil or Fitch. The rating is mentioned in the offer document.

3) Higher the Taxable Income, higher the return

These bonds are a best bet for investors in the higher tax brackets. Let us assume the actual rate offered on a tax-free bond is 8%. If you fall in the 10% tax bracket, you earn an effective pre-tax rate of 8.89%. An individual falling in the 20% tax bracket will earn a pre-tax rate of 10% and the individual falling in 30% tax bracket will earn a pre-tax rate of 11.43%  

4) Demat option is convenient

If you have a demat account, you should hold the bonds in demat form. It is easier to monitor your investment. You can also sell the bond in the secondary market, since these bonds are generally listed on the stock exchanges. 

RBI – Government ‘Jugalbandi’ to Bolster the Rupee

Both the Reserve Bank of India and the Government of India are likely to act in tandem this week to shore up the ailing Rupee.

Beginning from today the RBI will mop up Rs 22,000 Cr from the system every Monday by selling cash management bills. The reduction in the liquidity is likely to take some toll on those who are long on the dollar. This will strengthen the Rupee.

The Rupee which had closed last week at 60.88 against the U.S. Dollar is likely to begin its northern journey, where the first meaningful resistance is going to be faced at the 60 mark.

Readers would recall that in mid-July the  RBI had raised short-term borrowing rates and limited banks access to liquidity by way of restricting borrowing from the repo window just 50% of their entitlement. It had also asked banks to maintain the 99% of the CRR on a daily basis.

The steps of the RBI are likely to be complemented by a series of moves by the Government. The FM could announce the series of steps it intends taking in the Parliament today itself.

The approach is likely to be multi-pronged.

The aim is to build the confidence of the markets in the Rupee.

This will have to happen through a series of steps

1.   Tell the markets that it will not leave the rupee to fend for itself

2.   That it will do whatever it takes defend the Rupee

3.   Confidence will come and the Rupee will move north if the

A.   If the import duty on non-essential imports is hiked to the extent that it reduces consumption. Why should some on buying a fancy phone get the Dollar at the same rate as someone importing a lifesaving gadget?

So Expect Import duty hikes on Alcohol, Electronic items, Gold and even Toys and Fruits

B.   The War Chest of foreign currency is bolstered.

So expect steps that will encourage foreigners to invest in REITS, relax the ECB norms, raising FCNR deposit rates and coaxing public sector entities to issue bonds.

At the end of the day, the markets want to see credible steps being taken. And the Government should then walk its talk.

The Rupee is likely to appreciate in the morning itself in expectations of an announcement by the Government. The Rupee could then support the markets. But private sector banks, which are dependent on short term borrowing, are likely to move further south as they will be forced to cough up higher interest rates.