Not Worth The Wait

Really? A closer glance may prove otherwise. These days, domestic financial institutions (DFIs) have patented the art of creating an illusory world. IDBI's Flexibonds, the first bond issue to target retail investors, was a triumph of marketing wizardry. It reinforced the strength of the retail debt market. Tailormade to appeal to the common man with a promise of Rs 2 lakh after 25 years, and, with multiple options, the issue met with unprecedented success.

Returns classifcation: Sensing the mood of the market, others -- ICICI, SCICI, IFICI -- also hit the market with their respective issues. Each offering a bigger booty than the other over a slightly longer maturity period. All this even as the controversy as to whether the returns should be treated as interest income or capital gains snowballed.

 

Those who missed out on the four issues have found comfort in the news that the same institutions are planning to revisit the market very soon. Says SV Prasad, CEO, JM Capital Management, People go for these issues purely for sentimental reasons. Dig beneath the issuer's tall claims and you will find they do not tally with their actual returns.

Moreover, some experts (read sceptics if you will) see a parallel between this development and the infamous IPO boom of the early nineties.

High rates?: Give the investors the benefit of doubt. The final amount, around Rs 2 lakh and 5 lakh, gives a false sense of being a lakhpati. And it fails to register in their minds that the returns range between 15 and 17 per cent (compounded) in all these issues. This rate is achieved even from your other fixed-income bearing instruments.

For instance, your bank fixed deposits will fetch you 15 per cent and non-banking finance companies (NBFCs) will give you as much as 21 per cent. What is more, you do not have to lock up your money for as long as three decades. Even debentures, those poor cousins of DDBs, will give you between 17-18 per cent.

Then is it wise to park your funds in the DDBs for so long and, all things considered, so little? Yes, the returns are anything but spectacular. If the controversy regarding its taxation is anything to go by, you can be sure that the returns will be hacked further.

Says Atma Ramani, managing director, Tata Mutual Fund, These bonds have returns at a fixed rate. That means they can never be treated as capital gains for tax purposes.

Higher taxes: Which implies, almost certainly, that the returns will be treated as interest income. This means that you will be taxed at a higher rate say 30 or 40 per cent, as the sum involved is large. (See table) After all, you may have earned at least Rs 20,000 to exhaust the 15 per cent slab. Most likely, you will be taxed under both these slabs. This is almost double of what you thought you would be paying if taxed under long term capital gains.

A few financial wizards recommend the transfer of the bonds to your spouse or a third person in order to circumvent this tax. In such cases, it is claimed, capital gains will apply. But it is not sure whether the Central Board of Direct Taxes (CBDT) will keep the loophole open forever. Your guess is as good as ours.

An option like the public provident fund (PPF) may be safer. Here, you enjoy a 20 per cent rebate under section 88 of the Income Tax Act 1961 and the interest earned at a rate of 12 per cent is tax-free. Don't you think you are better off here? Says Samir Arora, vice-president, Alliance Capital, There is no sense in putting the post-tax money in these bonds.

Damocles' sword: Then, there is the call option (the institution's right to ask you to surrender the bonds), something that hangs over your fortunes like Damocle's sword. Though so far nobody has tried this out, there is no guarantee that there won't be a call before the maturity period.

Cautions a financial consultant, since most of these institutions are out to raise cheap, short-term money, this possibility cannot be ruled out. Those ill-fated IPOs, where the money went towards creating dud assets, can be cited as examples. The only difference here will be the term: non-performing assets (NPA) in bankers' lingo.

Or suppose the interest rate falls. In either situation the institutions can press the call button. However, chances of this happening, are very unlikely at least, for the next 10 years because a)there will not be such a big fall in interest rate, and b) institutions have to think about their goodwill and cost of raising the fund again. But, remember, what we are dealing with here is a much longer period.

Lastly, do not chase large numbers. Do you have any idea how much your Rs 2 lakh and Rs 5 lakh will cost after 25 or 30 years? For instance, when discounted at 10 per cent (providing for inflation), the Rs 5 lakh is whittled down to a mere Rs 23,654.28. Not much, right?

In short, if you opt for DDBs do so without any illusions. Get it right. these are instruments that offer merely moderate, fixed returns.