PSU Bonds Market

PSU Bonds Market

PSU bonds are medium and long term obligations issued by public sector undertakings.

PSU bonds issue is a phenomenon of the late 1980s when the Central Government stopped / reduced funding to PSUs through the general budget. PSUs float bonds in the primary market to raise funds. PSUs borrow funds from the market for their regular working capital or capital expenditure requirement by issuing bonds. The market for PSU bonds has grown substantially over the past decade. All PSU bonds have a built in redemption and some of them are embedded with put or call options. Many of these are issued by infrastructure related companies such as railways and power companies, and their sizes vary widely from Rs 10-1000 crore. PSU bonds have maturities ranging between five and ten years. They are issued in denominations of Rs 1,000 each

The majority of PSU bonds are privately placed with banks or large investors. In privately placed issues, rating is not mandatory while public issues are mandatorily rated by one or more of the four rating agencies in India. Historically, default rates of PSU bonds are negligible and PSUs are perceived as quasi-sovereign bodies. Usually, bonds issued by state owned PSUs carry interest payment and principal payment guarantee by the respective state government. Such guarantees are issued mainly to facilitate the fund raising programs for various long gestation infrastructure projects.

PSUs are permitted to issue two types of bonds: tax free and taxable bonds. Tax free bonds are bonds for which the amount of interest is exempted from the investor’s income. PSUs issue tax free bonds or bonds with certain exemptions under the Income Tax Act with prior approval from the government through the Central Board of Direct Taxes (CBDT) for raising funds for such projects. PSUs which have raised funds through the issue of tax free bonds are central PSUs such as MTNL and NTPC, and state PSUs such as State Electricity Boards (SEBs) and State Financial Corporations (SFCs). The bonds issued by the State Financial Corporations are SLR eligible for cooperative banks and non-banking finance companies (NBFCs). Interest on these bonds is calculated on Actual / 365 days basis. Tax deduction at source is applicable. In the pre-reform period, that is, before 1991, the maximum interest rate on taxable bonds was stipulated at 14 per cent and maximum interest rate on tax free bonds was fixed at 10 per cent. The ceiling of banks’ investment in PSU bonds was 1.5 per cent of incremental deposits. With effect from August 1991, the ceiling on interest rate on PSU bonds was removed and subsequently some of the PSUs floated bonds at an interest ate of 17-18 percent. Later, ceiling on tax free bonds was raised to 10.5 percent. The ceiling of bank’s investments in PSU bonds was also removed which enabled banks to invest freely in them.

Provident Funds were initially allowed to invest 15 per cent of their incremental deposit in PSU bonds. Later, this limit was increased to 30 percent.

The revised guidelines for the issue of PSU bonds were issued in October 1993. The guidelines indicate that the minimum maturity of tax free bonds should be seven years whereas PSUs will have the freedom to fix the maturities of taxable bonds. The public issues shall be subject to guidelines issued by SEBI.

PSUs are allowed to issue floating rate bonds, deep discount bonds, and variety of other bonds. All new issues have to be listed on a stock exchange.

Investors in PSU bonds include banks, insurance companies, non-banking finance companies, provident funds, mutual funds, financial institutions and individuals
Survey reveals a declining trend in the amount raised through the issue of tax free bonds. Since 1991-92, taxable bonds have become popular as the ceiling on interest rate of taxable bonds was removed. PSU bonds which traditionally were floated in the public issue market were privately placed in the 1990s. The PSUs preferred the private placement route for the issue of bonds. They did not tap the primary market for four consecutive years that is, from 1998-99 to 2001-02. The PSUs continued to tap the private placement market for their capital requirements.