The bonds, this time, have been announced to raise funds for infrastructure sector, especially for rail, road and irrigation projects.
After it seemed that the NDA government had shut the door on the tax-free bonds introduced during the UPA regime, it has made a comeback in the first full-fledged budget presented by the government after it took charge in May last year.
This time the tax-free bonds have been announced to raise money to fund infrastructure projects pertaining to rail, road and irrigation sectors. Tax-free bonds had no mention in July 2014 budget presented by finance minister Arun Jaitely.
The demand for the tax-free bonds this time came from public sector banks. During their pre-budget meeting with the finance minister, they had requested the government for long-term instrument for financing the infrastructure sector.
Presenting the budget for FY16, the finance minister said that there was a pressing need to increase public investment in infrastructure and outlined the steps he proposed to take to overcome the major slippage during the last decade on the infrastructure front.
In his budget speech, giving high thrust on infrastructure and making increased outlays, Jaitely said, “Our infrastructure does not match our growth ambitions. There is a pressing need to increase public investment. I have, therefore, increased outlays on both the roads and the gross budgetary support to the railways, by Rs 14,031 crore, and Rs 10,050 crore, respectively. The capex of the public sector units is expected to be Rs 3,17,889 crore, an increase of approximately Rs 80,844 crore over revised estimate (RE) for 2014-15. In fact, all told, investment in infrastructure will go up by Rs 70,000 crore in 2015-16, over 2014-15 from the centre’s funds and resources of central public sector enterprises.”
Tax-free bonds will be one of the long-term fund raising instrument for ensuring the fund flows to the infrastructure sector as Jaitley said, “I intend to establish a national investment and infrastructure fund (NIIF), and find monies to ensure an annual flow of Rs 20,000 crore to it. This will enable the trust to raise debt, and in turn, invest as equity, in infrastructure finance companies such as the Indian Railway Finance Corporation (IRFC is a dedicated financing arm of the ministry of railways with sole objective to raise money from the market to part finance the plan outlay of Indian Railways) and National Housing Bank, the principal agency to promote housing finance institutions and to provide support to such institutions. The infrastructure finance companies can then leverage this extra equity, many fold.”
However, the re-introduction of the tax-free bonds has invited some criticism as market feels the finance minister should have announced tax deductible bonds instead of tax-free bonds, as the latter will only benefit the rich who have already exhausted the tax exempt investment options and are still having enough money to deploy in tax-free bonds. As there is no tax deduction benefit available for the invested amount, lower income groups have no upfront gain by investing in them when other options provide upfront tax exemptions. In the past tax-free bonds were mainly subscribed by the high net worth individuals due to the attractive tax-free returns as the limit is quite generous at Rs 10 lakh in the primary market issues and no limit in the secondary market for these long tenure papers.
Normally, there is little here for the middle class, which is hardly able to exhaust already available options like Rs 1.5 lakh under section 80C for personal provident fund, life insurance, employee provident fund, national pension scheme, mutual funds’ equity linked saving scheme and five-year fixed deposits.
Though the interest earned on the proposed bonds is tax-free, any capital gain from sale in the secondary market is taxable. Short-term capital gains from sale of tax-free bonds on exchanges are taxed at the normal rate, while long-term capital gains are taxed at 10 per cent without indexation and 20 per cent with indexation, whichever is lower. By indexing, one can adjust the purchasing price with annual inflation. Also tax-free bonds may not be priced attractively this time around with interest rate cycle witnessing a downhill trend. The coupon (interest) rates of tax-free bonds are linked to the prevailing rates of government securities. So these bonds become attractive when the interest rates in the financial system are high.
Pricing of tax-free bonds is based on 10-year government of India bonds yield, with the yields dropping to 7.65 per cent to 7.67 per cent and expected to touch a low of 7.25 per cent, the coupon rate for the bond is likely to drop this time to a lower rate of around 7.25 per cent to 7.50 per cent.
For those who cannot exhaust Rs 1.5 lakh personal provident fund limit, which also gives 8.7 per cent tax-free return, there is no need to go for or look for these tax-free bonds that may hit the market only in the second half of FY16, roughly around or after September-October 2015.
The bonds issued by government backed public sector undertakings in 2011-12 had coupon rate of more than 8 to 8.4 per cent, in 2012-13 there was a dip in the coupon rate to 7 to 8 per cent in line with the government securities yield, but the tax-free bonds issued in 2013-14 had interest rate as high as 9.01 per cent due to surge in the government securities yield to 8.5 per cent in 2013 as these bonds pricing formula tracked the yield of benchmark government securities. Last year after the finance minister did not announce issue of fresh tax-free bonds, the secondary market of the tax-free bonds saw firming up of demand and price of existing tax-free bonds issued in 2012, 2013 and 2014 from the investors in the market.
Tax-free bonds have emerged as a sound investment option due to their high coupon rate and tax-free return for long tenures of 10, 15 and 20 years. National High Authority of India was the first company to issue tax-free bonds in 2012.
The income by way of interest on these bonds is fully exempt from income tax and does not form part of total income as per provisions under section 10 (15) (iv) (h) of IT Act, 1961. These bonds issued by government-backed entities also have very low default risk.
The bonds, which came with long tenures of 10, 15 and 20 years, can be traded on the listed stock exchanges, National Stock Exchange and Bombay Stock Exchange, if held in dematerialised form as against physical form.
But while buying in the secondary market there is added cost of brokerage and price appreciation as compared with initial issue when the spreads are narrow. “There is spread as well as brokerage added to the cost. But now the spread between buying and selling is narrowing as the liquidity is increasing,” said an analyst said.
The secondary market action for already issued tax-free bonds will be much more intense now with RBI’s second 25 basis point cut in the repo rate bringing the yield of 10-year government bonds to around 7.65 per cent.
The tenure of these bonds, which is as long as 15 and 20 years may now get revised in the forthcoming issuances and 10 years and 15 years, may be the preferred tenure to provide an early exit for the investors who will try to lock them for 10-15 years tax-free returns rather than early exits on price appreciation.
It will be interesting to see if the new bonds offer additional coupon rate to the retail investors to make it attractive for them as in the past. With the announcement of tax-freed bonds, the secondary market has seen some action for existing IRFC and NHB bonds having lower coupon rate of less than 7 per cent with their prices falling while those with higher coupon rate inching up.
However, daily volumes for the tax-free bonds have only marginally improved with some individual bonds attracting daily trades of more than 1,000 units while others remaining below 1,000 units a day.
No comments:
Post a Comment