Sovereign wealth funds have shunned tax-free bonds issued by state-run Indian companies and financial institutions despite the government’s attempts to woo these foreign funds in the numerous overseas road shows by finance minister P. Chidambaram.

A volatile rupee, the lack of any specific tax advantage and unattractive interest rates have ensured that not even one issue has been subscribed by these wealth funds, according to officials from these financial institutions and merchant bankers.

The entities were Indian Railway Finance Corp. Ltd (IRFC), India Infrastructure Finance Co. Ltd (IIFCL), the National Highways Authority of India (NHAI), Power Finance Corp. Ltd (PFC), Rural Electrification Corp. Ltd, Housing and Urban Development Corp. Ltd and National Housing Bank.

A sovereign wealth fund is a state-owned investment fund that invests in various financial instruments across the world. India has been wooing sovereign wealth funds based in West Asia and other countries as part of its plan to counter foreign outflows due to a tapering of the bond-buying programme by the US Federal Reserve.

In one of these steps, the Central Board of Direct Taxes in August allowed 13 entities to raise up to Rs.48,000 crore through tax-free bonds. For the first time, a clause was inserted that these institutions had to set aside a portion from the issuances for sovereign wealth funds.

But later, institutions that had been allowed to raise less than Rs.1,000 crore were exempted from this clause after these institutions told the government that these issues are too small.

Tax-free bonds are long term in nature and their proceeds are invested in infrastructure. In a tax-free bond, the interest income is exempted from income tax, which is an advantage for domestic investors but not for overseas investors who may have to pay tax in their countries, depending on the laws there.

“We had approached sovereign wealth funds through our merchant banker. But no one showed interest,” said an official with IIFCL. “There are no tax advantages for foreign investors despite the lower withholding tax rate of 5%. Domestic investors at least get tax advantages.”

“It is the same story for everyone (all other companies that are raising bonds),” he said, requesting anonymity.

The government even reduced the rate of tax on interest paid to overseas investors who invest in such bonds to 5% from 20%.
Officials from IRFC, NHAI and PFC confirmed that they did not receive any foreign fund participation. None were willing to be named. Emails sent to the other financial institutions on 19 December remained unanswered.

“The coupon rate of 8-9% offered by these bonds is not attractive enough for these investors,” said an NHAI official.

Compared with other investment options in India, tax-free bonds may not be very attractive for foreign funds, said Jyoti Prakash Gadia, managing director of Resurgent India Ltd, an investment bank.

“Compared to stocks or other bonds, price appreciation of tax-free bonds may not be much if an investor is looking to sell,” Gadia said.