Go for Bonds only If You have the Patience

Gentlemen prefer bonds is an old investing adage. But going by the recent response to bond issues, it seems bonds are the choice of retail investors as well.

While State of India’s recent Rs 1,000 crore bond issue was subscribed 17 times IDFC got 235,750 investor applications with investments totaling about Rs 436 crore for the first tranche of its just concluded tax savings long term infrastructure.

While the income tax deduction on infrastructure bonds (under section 80CCF) is limited to a maximum of Rs 20,000 a year, the IDFC bond attracted an average investment of around Rs18,500 per application. This perhaps is a reflection of the average investor’s eagerness to tap a debt focused tax savings product that gives largely secure returns. It is an attractive option for fixed income investors who are looking to save tax. These bonds would be able to generate higher returns than bank fixed deposits and post office savings scheme

Infrastructure bonds that are available in the market offer 7.5 – 8% annual returns and L&T’s tax saver long term infrastructure bond is open for subscription now. Some offer cumulative tax adjusted returns of up to 10.2%

However, the yield from infrastructure bonds cannot exceed the 10 years government bond yield at the time of the issues.

The bond issuers would use the money raised to fund infrastructure projects. Since a large number of fixed income investors don’t have a demat account, firms offering infrastructure bonds allow investment to be held in the physical forms.

But you have to go well beyond the fine print and understand the tax implications and the low liquidity offered by the instrument before taking a decision. And for investors in the lower tax slab (10.3%) these bonds may not make much of a difference. A person in this slab can save only about Rs 2,000 in taxes and earn Rs 1,500 as interest in a year.

It (infrastructure bonds) will not have (much) appeal for investors in the lower tax slabs. However those in the 30% tax slab can save up to Rs 6,180 in taxes.

Infrastructure bonds also come with long lock in period of five years. With no big secondary market for fixed income products, these bonds don’t offer much liquidity for the investors. The five year lock in is a big discouragement for investors Infrastructure bonds (in their earlier avatar) had three year lock in but this one is a bit long.

However, these bonds are the best alternative asset in the debt a category and would be able to beat inflation in the long run an industry official says This (infrastructure bonds) is the starting process for reaching fixed income products to a wider section of the investing community.

The incremental issuance of government securities due to higher borrowing requirements started in November. Such a significant supply without a corresponding demand has pushed yields of such securities higher at every auction. This is in spite of the fact that Open Market Operations were conducted by RBI at regular intervals to enable market participants to unwind their securities to create space for the fresh supply.

Further, when the government presented an interim Budget for 2009-10 the fiscal deficit estimated was 5.5% of the next year GDP. This resulted in estimated gross borrowing of around Rs 3.6 lakh crore and net borrowing of around Rs 3 lakh crore next year. The market lacks clarity on whether such a huge supply can be absorbed well by matching demand. It is due obvious that any negative gap in demand is likely to push the yields higher.

A borrowing calendar for the first six months has been announced recently for total amount of Rs 2.4 lakh crore. This is almost two-third of the total gross borrowing announced. This front loading is partly because of the redemption of dated and MSS securities coming up for redemption in the first three months. The market suspects that RBI is creating space for further issuances, if needed by the government, in the second half.

This can effectively push the fiscal deficit, borrowing program and issuance of securities for the whole year to much higher level than envisaged. The uncertainty on this front is keeping the market players on tenterhook preventing them from creating any serious demand on the government securities. RBI has announced buyback of securities to the extent of Rs 80,000 crore through open market operations for same period in an effort to ease the situation.

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