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Lock into High Rates on Infra Bonds

  • Choose the cumulative option which ploughs back your interest and the buyback option which allows you to exit if better rates are available elsewhere.After being introduced in 2010-11, infrastructure bonds are back in action this year. While IFCI and Power Finance Corporation (PFC) issues closed in November, subscription to long-term infrastructure bonds from IDFC (Infrastructure Development Finance Company) and L&T Infrastructure Finance Company (L&T Infra) is currently open.These bonds have always been eligible for tax benefits but the key attraction of investing in the current bond offers is their high yields.
  • With yields on government securities now at a multi-year high and likely to peak out, current infrastructure bond offerings have pegged their interest rates at 9 per cent per annum. Investors should lock into these bonds, to capitalise on this opportunity.Infra bonds are an attractive option for individuals in the higher tax brackets due to their tax benefits.Issued under Section 80CCF of the Income-Tax Act, investments up to Rs 20,000 are tax exempt. This option is available over and above the Rs 1, 00,000 savings limit under Section 80C for investors.

TAKE FULL ADVANTAGE

  • The interest rates on these bonds are linked to the yields on 10-year government securities.With successive rounds of monetary tightening, yields have become very attractive in recent times.However, with the slowing economy, the RBI is expected to adopt a wait-and-watch approach before hiking interest rates any further, indicating that the yields may have reached a peak.Already, the 9 per cent coupon rate offered on these two bonds is higher than the 8.5 per cent offered by PFC for its 10-year bonds recently. Hence, investors can take full advantage of these offers to exhaust the entire limit of Rs 20,000 as other bond issues which may come up in the January-March 2011 period are unlikely to be as attractive.
  • This is especially relevant for those who would have taxable income even after exhausting the 80C limit of Rs 1 lakh.Others having surplus funds and looking to maximise returns can consider 5-year tax saving deposits from banks, some of which offer higher rates. City Union Bank, for example, offers 9.5 per cent interest for its tax saver deposits.Besides the investment being eligible for deduction under Section 80C, these deposits are also covered by deposit insurance up to Rs 1 lakh.

CUMULATIVE AND BUYBACK OPTION

  • That said, those investing in these infrastructure bonds can go in for the cumulative and buyback option.Investors need not choose the annual payout option as the cash flows will be trivial on a Rs 20,000 investment.Besides, the cumulative option gives the benefit of reinvestment of interest at the coupon rate.The buyback option offers the flexibility to exit if better rates are available on alternative debt instruments after the lock-in. For both the L&T Infra and IDFC bonds, the yields are also the maximum for the cumulative and buyback option (5 years). The tax exemption on the initial investment significantly improves the yields on such bonds. Investors in a higher tax bracket will be able to enjoy greater benefits than those in a lower slab.
  • For the 30 per cent tax bracket, post-tax yields stand at 14. 7 per cent. For those in the 20 and 10 per cent brackets, yields are at a 12.45 per cent and 10.58 per cent respectively.The L&T Infra bond also offers a buyback option after 7 years for the same 9 per cent coupon rate. Investors need not choose this, as the yields are lower. For the 30, 20 and 10 per cent tax brackets, post-tax returns are at 12.46, 11.08 and 9.95 per cent respectively.Besides, as the L&T Infra bonds are to be listed in the BSE (Bombay Stock Exchange) and the IDFC bonds, in both the BSE and NSE (National Stock Exchange), investors can exit through the markets after the initial lock-in period of five years. When transferred, it will be treated as long-term capital asset and be subject to capital gains tax. Such exit will, however, be exposed to interest rate movements which can depress or shoot up bond prices.

THE COMPANIES

  • IDFC enjoys AAA rating by ICRA and Fitch indicating highest safety and stable outlook. Fitch too has given AAA rating for the company indicating long-term stable outlook.Its capital adequacy ratio as on September 30, 2011 stood at 22.87 per cent and its net NPA ratio, at 0.09 per cent.L&T Infra is a relatively new player, incorporated in 2007. It has, however, scaled its infrastructure loan portfolio to Rs 8,768 crore, as at end of September 2011. It enjoys an AA+ credit rating from both CARE and ICRA, indicating high safety for timely servicing of debt obligations.While IDFC looks safer for the conservative investor, those wanting to exhaust the Rs 20,000 limit need not put all their eggs in one basket. The IDFC issue closes on December 16; L&T Infra offer closes on December 24, 2011.

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