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Tax-free debts possible end driving bond demand
March, 05th 2014

India’s biggest underwriter is recommending investors buy tax-free bonds returning the equivalent of 13% because a change of government may end the programme.

Prime Minister Manmohan Singh’s administration refrained from allocating tax-free note limits for state companies in its interim budget last month. Opinion polls show his Congress party losing power in elections that must be held by May. Rural Electrification Corp. Ltd is marketing 15-year tax-free paper at 8.88%, 81 basis points less than regular securities. The return is equivalent to taxable debt paying 12.9%.

“This is the best investment opportunity available for investors at the moment because the returns are very high,” said Shashi Kant Rathi, Mumbai-based head of debt capital markets at Axis Bank Ltd, India’s biggest underwriter since 2007. “Investors also stand to make a profit on these bonds because of the uncertainty over whether they’ll be continued after the elections.”

India’s government set up the programme to help fund as much as $1 trillion of investment by 2017 to improve infrastructure that’s ranked worse than Kazakhstan and Guatemala by the World Economic Forum. Five-year AAA rated regular corporate bonds in India yield an average 9.36% versus 5.29% for similar notes in China, data compiled by Bloomberg show.

Best available
Tax-free rupee-denominated bonds of state-owned companies offer investors some of the best returns available for the least amount of risk, according to Axis Bank. Indian Railway Finance Corp., the financing arm of the state rail network, is marketing 10-year notes whose interest isn’t taxed at an equivalent yield of 12.2%.
India Infrastructure Finance Co., the New Delhi-based lender to transport and utility networks, is offering a 12.7%-equivalent yield on 20-year tax-free debt, while National Housing Bank, the regulator to mortgage companies, plans to raise as much as Rs.1,000 crore selling the securities in a sale expected to close on 18 March, a person familiar said on Tuesday.

India’s government boosted the tax-exempt bond limit for this fiscal year by Rs.2,000 crore to Rs.50,000 crore last month by allocating an additional Rs.1,000 crore each to Rural Electrification, a lender to power projects, and National Housing Bank, according to a Central Board of Direct Taxes notification dated 13 February.
Investor rush

NTPC Ltd, the nation’s biggest electricity producer, was also permitted to raise an additional Rs.500 crore via untaxed notes, while an earlier allotted limit of Rs.500 crore to Airports Authority of India was withdrawn.

Authorities gave permission to 12 state-controlled companies to issue tax-exempt securities by 31 March. They have so far raised about 80.4% of the alloted total with public issues of about Rs.7,560 crore still open for subscription, according to data compiled by Bloomberg News.

“With no mention of tax-exempt bond issuance in the interim budget and only 10 to 15 days left for companies to sell such notes, investors must rush to invest,” said Rajiv Datt, Indian Railway Finance’s New Delhi-based managing director.

Infrastructure companies in India can sell tax-free bonds in tenors of either 10-, 15- or 20-years and the coupon must be linked to the sovereign bond yield, according to an 8 August Central Board of Direct Taxes notification.

Power plants, ports
Ten-year government bonds registered their worst performance since November last month on concern a decline in central bank debt purchases will lower demand. The 8.83% sovereign note due November 2023 is yielding 8.84%, after rising 9 basis points in February.

Reserve Bank of India (RBI) now prefers injecting funds through term repurchase-contract auctions rather than open-market purchases of long bonds, said Dwijendra Srivastava, head of fixed income at Sundaram Asset Management Co., in a 28 February phone interview, adding, the central bank has absorbed about 20-25% of the government’s debt issuance in the past two years.

RBI Governor Raghuram Rajan unexpectedly increased interest costs in January, boosting the benchmark repurchase rate to 8% from 7.75%. He warned on 23 February that inflation remains the biggest threat to the Indian economy.

Rajan, who has raised borrowing costs three times since taking office in September, said any further action will depend on data. Wholesale prices rose 5.05% in January from a year earlier, the least since May, while the consumer-price index jumped 8.79%, the smallest gain in two years.
India’s BSE Sensex has gained 0.2% this year after rising 9% in 2013. The currency has dropped 0.1% against the dollar since 31 December and gained 0.3% on Tuesday to 61.8575.

National elections
India’s economy may remain weak in January to March with a gradual recovery in the growth rate to 5.5% next year, Goldman Sachs Group Inc. analysts Tushar Poddar and Vishal Vaibhaw wrote in a note dated 2 March. Gross domestic product (GDP) rose 4.7% in the three months to 31 December from a year earlier, compared with 4.8% the previous quarter, government data showed on 28 February.
India’s full-fledged budget will be presented by the government that’s formed after the national elections. The country’s main opposition Bharatiya Janata Party (BJP) could emerge as the largest party while falling short of a majority, according to a 24 February opinion poll by ABP News television channel and Nielsen.
“There’s a lack of clarity over whether such instruments will be continued next financial year,” Nirav Dalal, the managing director of Yes Bank Ltd’s fixed-income and debt capital markets division said. “Tax-free bonds are the finest avenue available for long-term investments given the high yield and strong credit profile of the borrowers.” Bloomberg

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