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Lower interest rates may keep investors away from tax-free bonds
May, 02nd 2013

Tax-free bonds of state-run institutions, which last year received a lukewarm response from investors, are likely to find only few takers this year too as the finance ministry is planning to keep the coupon rate on these bonds below the prevailing rate on government securities.

“If you have to offer a higher rate than G-Sec then what is the point in giving tax incentives. It doesn’t make sense for the government to forgo tax and then borrow at a higher cost,” a finance ministry official, who did not wish to be identified, said referring to the coupon rate on this year’s bond.

In Budget 2013-14, the government earmarked Rs 50,000 crore for tax-free bonds for encouraging long-term investment in the infrastructure sector, but put a rider that these would be allowed strictly based on the need and capacity of an institution to raise money in the market.

Last year, it had sanctioned Rs 53,500 crore for 10 state-run institution but those could barely raise Rs 14,763 through public issue and about 4,000 crore through private placement. Brokers attributed the poor response to the coupon rate that was kept 50-100 basis points lower than the G-Sec rate.

Prithvi Haldea, CMD, Prime Database, said usually people who have parked their money in fixed deposits would look at these bonds and they would subscribe to these bonds only if the coupon rate is at least 200 basis points higher than other saving instruments.

According to the finance ministry, however, slower economic growth rather than the interest rates kept investors away from these bonds last year, whereas some cash-rich companies like the National Highways Authority of India did not feel the need to tap this route.

A senior executive at an institution, which issued these bonds last year, said the response was poor because of a restriction under Section 372A (3) of the Companies Act. On March 14, the government clarified that in cases where the effective yield on tax free bonds is greater than the yield on prevailing bank rate, there is no violation of the Act. This clarification will help this year, he added.

In the current financial year, the permission to issue bonds would be given after assessing cash position by these institutions last year. Companies which were not able to utilise the window last year may not get a second chance, while some new entrants could be considered for floating tax-free bonds this year.

“We will review requirement of individual entities as to whether they are ready for it. Some are saying they got the permission for the issue very late. We will see which sector has to be given importance. Ports have lot of cash. Capability of NHAI to absorb more funds will be assessed,” said another official.

Last year, the government had made the norms for tax-free bonds more stringent by tightening commission and lowering the rate. Since public issues did not fetch much, many institutions turned to private placement though the finance ministry had discouraged it. Investors such as bodies corporate, societies, cooperative banks, trusts were not eligible to subscribe to these bonds.

Officials said broadly the objectives in the current year would remain the same and the government would ensure that the benefit is not cornered by a few.

Housing and Urban Development Corporation, India Infrastructure Finance Company, Power Finance Corporation, Rural Electrification Corporation, National Housing Bank, Indian Railway Finance Corporation, Jawaharlal Nehru Port Trust, Ennore Port, and Dredging Corporation of India floated tax-free bonds in 2012-13.

State-run institutions had raised Rs 30,000 crore in 2011-12 as high effective yield of 11% to 12% attracted high net-worth individuals to these instruments.

Company Sanctioned Raised Through Public Issue
NHAI 10,000 --
IRFC 10,000 5,802
IIFCL 10,000 3,156
Hudco 5,000 2,401
NHB 5,000 196
PFC 5,000 865
REC 5,000 2,148
JNPT 2,000 41
Emore Port 1,000 95
DCI 500 59
Total 53,500 14,763
Figures are in Rs crore

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