This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in
Amid volatile stock markets, rising interest rates and weakening economic growth, the investors are running out of patience now, even with their so-called “safe debt investments” in the form of debt mutual funds, including the ‘safest’ liquid funds. They now want only those investments in their portfolio which are offering fixed guaranteed returns, even if the returns are lower than debt mutual funds.
One such investment, which has been really attractive for them for the past few years, is Tax-Free bonds. The Central Board of Direct Taxes (CBDT) has notified the rules on issuance of tax-free bonds for the current financial year – 2013-14. In the budget this year, the Finance Minister P Chidambaram proposed tax free bonds to the tune of Rs. 50,000 crore, the size of which, as per the notification, has been cut to Rs. 48,000 crore.
The notification for the tax free bonds for the current financial year got issued by the CBDT on Thursday, August 8th. Here is the Taxmann link to the notification.
There are a few changes in the rules for this year’s bond issuances as compared to the last year and I will list out all those changes later in the post. Let us first check out the features and other details of the notification.
Thirteen companies in the infrastructure development or infrastructure finance space have been authorised to issue tax-free bonds this year, namely IIFCL, IRFC, NHAI, REC, PFC, HUDCO, NHB, NTPC, NHPC, IREDA, AAI, Ennore Port and Cochin Ship Yard. These bonds will be issued for 10 years, 15 years or 20 years. It is not clear though which entities will be allowed to issue these bonds for 20 years. Last year, only IIFCL was allowed to issue these bonds for 20 years.
Here is the list of all these entities along with the stated limits of amount to be raised through these tax free bonds:
The investors have been classified in the following four categories:-
1) Retail Individual Investors (RIIs)
2) Qualified Institutional Buyers (QIBs)
3) Corporates
4) High Net Worth Individuals (HNIs)
The definition of a Retail Individual Investor has been left unchanged this year. As per the notification, Retail Individual Investors would mean those individual investors, Hindu Undivided Families or HUFs (through Karta), and Non Resident Indians (NRIs), applying for up to Rs. 10 lakhs in each issue. Individual investors investing more than Rs. 10 lakhs will be classified as High Net Worth Individuals (HNIs).
The companies are allowed to issue these bonds either through public issues or private placements. As per the notification, at least 70% of the authorised amount of bonds issued by each entity will have to be raised through public issues. For instance, if IIFCL raises Rs. 10,000 crore from these bonds this year, then Rs. 7,000 crore out of it will have to be raised through public issues only and the rest Rs. 3,000 crore, IIFCL can raise through private placements.
Like last year, there would be an applicable ceiling on the coupon rates offered by the issuer companies, based on the reference Government security (G-sec) rate. The ceiling coupon rate for a AAA rated issuer company will be 55 basis points (or 0.55%) less than the reference G-sec rate in case of Retail Individual Investors and 80 basis points (or 0.80%) less than the reference G-sec rate in case of other investors, like Qualified Institutional Buyers (QIBs), Corporate and High Net Worth Individuals (HNIs).
In case of issuer companies having credit rating of AA+, the ceiling coupon rate will be 45 basis points less than the reference G-sec rate in case of Retail Individual Investors and 70 basis points less than the reference G-sec rate in case of other investors.
In case of issuer companies having credit rating of AA or AA-, the ceiling coupon rate will be 35 basis points less than the reference G-sec rate in case of Retail Individual Investors and 60 basis points less than the reference G-sec rate in case of other investors.
In case the issuer company decides to make the interest payments semi-annually, it will have to lower the coupon rate by 15 basis points or 0.15%.
As per the notification – “The reference G-sec rate would be the average of the base yield of G-sec for equivalent maturity reported by Fixed Income Money Market and Derivative Association of India (FIMMDA) on a daily basis (working day) prevailing for two weeks ending on Friday immediately preceding the filing of the final prospectus with the Exchange or Registrar of Companies (ROC) in case of public issue and the issue opening date in case of private placement.”
There are quite a lot of things which would make the retail investors happy this year.
1. The coupon rates to be offered this year will be higher than the last year and there are two reasons for that. One, the yields on government bonds have risen this year as compared to the last year when these bonds got issued. Second, the cap on the ceiling coupon rate will get higher as the deductions from the reference rates have been lowered to 55-80 basis points as compared to 65-115 basis points of last year.
The demand from the QIBs, corporates and HNIs was very muted last year as the cut from the reference rates was quite high at 115 basis points (or 1.15%). This year it has been lowered to 80 basis points (or 0.80%). I think their demand for these bonds would be higher this year and it would also help increase liquidity in the secondary markets.
2. One thing which is very important to notice here is that the difference between the rates offered to the retail individual investors and the other categories of investors has been cut down to 25 basis points (or 0.25%) only, as compared to last year’s 50 basis points (or 0.50%). I think this factor also would attract higher participation from the other categories of investors and thus increase liquidity in the secondary markets.
3. As per the notification “The higher rate of interest, applicable to RIIs, shall not be available in case the bonds are transferred by RIIs to non retail investors”. Till last year, only the first allottees were eligible for a higher rate of interest and the subsequent buyers from the secondary markets were supposed to get a lower rate of interest. The language of the notification suggests me that the interest rates earned by the retail individual investors (RIIs) this year would remain higher even if they buy it from the secondary markets subsequent to the offer period. This factor will have greater participation from the retail investors in the secondary markets and thereby result in higher liquidity.
4. Like last year, in case of public issues, 40% of each such issue will be reserved for the retail investors category. So, there is no cut in the reserved portion of the retail investors.
As the 10-year benchmark G-sec yield touched 8.40% today, it would be good for these companies to come out with such issues soon so that they are able to attract sufficient participation from the investors. But, at a time when the economy is in a really bad shape and companies are reluctant to do any kind of capex, do these companies really require these funds for infrastructure development or for further lending?
Some of these companies, like NHAI, are already sitting on a huge cash in their books and are unable to properly utilise this money and some of these companies, like PFC and REC, are wasting these funds in debt restructuring of state electricity boards (SEBs). I don’t know whether it would be wise to invest in these bonds from value-addition point of view, but from returns point, I think it would be a good opportunity for the investors in the 30% and 20% tax brackets.
