Tax-free bonds seen receiving tepid response in FY16

Bond yields rise to two-month high due to higher inflation

Tax-free bonds which are seen hitting the street in the financial year 2015-16 may not be able to get the same attention it had got when interest rates were higher. This is because the coupon rates on these bonds are expected to be much lower than what was offered earlier.

Last month the Budget had announced tax-free bonds for infrastructure projects. Tax free bonds are popular with high net worth individuals as the interest is tax free. If the holding period is more than one year, investors have to pay long capital gains taxed at 20% with indexation or 10% without indexation.

“Since interest rate cycle is heading down, the coupon rate on these bonds may not be so high due to which though the bonds may still get subscribed, but the enthusiasm of investors may not be as good as it was in the past years. Investors may continue to have higher interest in equity investments,” said Arvind Konar, head of fixed income, Almondz Global Securities.

The bonds offer a high degree of safety as they are issued by top rated public sector companies. In the past, issuers such as Rural Electrification Corporation, Power Finance Corporation and National Highways Authority of India have hit the market with such bonds. Since the interest rates were higher at that time, these issues had got subscribed very fast.

“There is still clarification needed on when the tax-free issuances will come and how they would be priced. If you look at the pricing last fiscal, it was related maturity of g-sec yields minus 85 bps. That was the maximum coupon issuers could offer in the related maturity. This time if the same pricing criteria is retained, the coupon rate on tax-free bonds will be near around 7% . So it will not be as attractive as last time. Normally investors are interested in tax-free bonds when coupon rate is around 8%,” said Ajay Manglunia, senior vice-president (fixed income), Edelweiss Securities.

Meanwhile, the yield on the 10-year benchmark bond ended at a two-month high at 7.80% on Friday compared with previous close of 7.72%. The yield was last seen near this level on January 12 at 7.81%. Bond yields climbed on concerns that the central bank may not cut interest rates further in the next monetary policy due to retail inflation inching up. 

Consumer Price Index (CPI) -based inflation rose to 5.37% in February, from 5.19% the previous month, mainly because of high food prices. Reserve Bank of India (RBI) will announce the first bi-monthly monetary policy statement, 2015-16 on April 7.