Poor returns, supply overhang: No takers for tax-free bonds

The market for tax-free bonds will now be limited to the super rich and retail investors, while insurance firms and mutual funds may stay off because they are not taxed on the interest income or coupon of the debt they buy.

hidden December 20, 2014 17:17:46 IST
Poor returns, supply overhang: No takers for tax-free bonds

India's plan to double the issue of tax-spared bonds in the financial year beginning April to build highways and railroads is unlikely to find many takers because of a supply overhang and poor returns.

Poor returns supply overhang No takers for taxfree bonds

The 15-year HUDCO bond is trading currently at Rs 960, 4 percent below its issue price of Rs 1,000, while IRFC bonds are also currently trading below their issue price. Reuters

The government has set a target for such issues at Rs 60000 crore by infrastructure finance companies in 2012-13, which would be used to bridge the shortfall in cash to fund large projects.

"There is an overhang of tax-free bonds in the market now so more supply will only be difficult to get absorbed," said Nirav Dalal, managing director and country head of fixed income and debt capital markets at YES Bank.

Poor market debut of Housing and Urban Development Corp's bonds after the budget in March is also expected to dampen investor demand. Indian Railway Finance Corporation, on the other hand, listed with a wafer-thin premium of Rs 9 per Rs 1,000 bond, disappointing traders.

The 15-year HUDCO bond is trading currently at Rs 960, 4 percent below its issue price of Rs 1,000, while IRFC bonds are also currently trading below their issue price.

"The doubling of the issuance quantity is going to act as a drag on the price of the tax-free bonds that have been issued so far," Dalal said.

A senior dealer with a foreign bank said excessive supplies could also push traders to more liquid government and corporate bonds.

The coupon rates on the tax-free bonds, set at up to 100 basis points lower than the annualized government bond yield at the end of the previous month for similar maturity, also shuts out many large investors, such as corporates.

REGULATORY BUMPS

Companies are not allowed by law to invest in corporate bonds that pay less than the bank rate of 9.5 percent, while the yields on the tax-free bonds usually range from 8 percent to 8.50 percent.

The bank rate was raised by 3.5 percentage points in February, bringing it at par with the marginal standing facility rate, the highest rate at which the central bank lends to banks.

"The inability of the corporates to buy because the coupon on tax-free bonds is lower than the bank rate will hit the demand for these bonds," Dalal said.

Bureaucratic red tape can also spook issue plans.

National Highways Authority of India, IRFC, IIFCL and the power sector can raise Rs 10000 crore each, the finance minister said in the 2012/13 budget.

National Housing Bank, SIDBI, HUDCO and ports can raise Rs 5,000 crore each.

However, companies that have secured approvals to raise funds still need a government notification before they can offer tax-free bonds and this usually takes time.

In 2011/12, the notification was issued in September - six months into the financial year - leading to a clutter of deals hitting the market in a shorter span of time and some of the individual limits were not utilized, one company official said.

The market for tax-free bonds will now be limited to the super rich and retail investors, while insurance firms and mutual funds may stay off because they are not taxed on the interest income or coupon of the debt they buy.

Reuters

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