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Infrastructure Bonds And Other Alternatives

  • Infrastructure bonds are widely welcomed by salaried individuals who were demanding an increase in the tax break to more than 1, 00,000 rupees. It has given them another avenue to invest to save tax. Let's take a look at other such available investments which provide a fixed income.

Debt-oriented mutual funds

  • The other debt instruments available for investment are debt-oriented mutual funds. These funds allocate major part of the fund in government securities, corporate bonds and debentures, and sometimes in fixed deposits. They can be a good alternative. However, even though they are debt-oriented funds, a small part (up to 30 percent) goes towards equity. Hence, investors do see fluctuation in returns. The average returns from debt-oriented funds over a period of time can be about 12 percent, depending upon the market condition and the proportion of fund invested in equity.

Bank fixed deposit

  • The other option is banks where the rate of interest has gone up. Few banks are giving good returns on fixed deposits. For example, Bank of Baroda is giving over 9 percent returns on fixed deposits of duration above one year. This is a certainly a better return in absolute term. Some other banks are offering similar rates on fixed deposits.

Fixed maturity plan (FMP)

  • Some mutual funds are also known as FMPs or fixed maturity plans. FMPs are as good as fixed deposits and offer an ‘expected' return of 9 to 10 percent. The returns are expected because there is always the risk of corporate default. So, tax exemption is the biggest advantage that infra bonds provide. But the interest received on infra bond is taxable.

Investors' response

  • Infrastructure bonds have seen tremendous response from retail investors for tax-saving purpose. The demand goes up before the end of the financial year. Even though it is a big hit among salaried individuals and retail investors, the bonds did not impress big ticket investors in India and abroad because they are more focused on getting better returns than saving tax. To encourage response from FII, the government is planning to reduce the lock in period of infra bonds. The lock-in period currently is 5 years. In all probability, this may come down to 1 year. The reduced lock-in period may be able to bring foreign capital for infrastructure projects which are delayed because of lack of funds. Ideally, reducing the lock-in period should bring more investors, both domestic and multinational. This seems to be a good way to increase participation and transaction. However, the downside of this is that it will increase speculative investment. Retail investors anyway invest in infra bonds to save tax and hence there isn't much scope left in retail segment.

Important points to keep in mind

  • Keep in mind that the tax benefit is limited to just 20,000 rupees. Hence, investment beyond this will not be eligible for tax exemption. The disadvantage of infra bonds is the lock-in period and the taxable interest.
  • Second, don't forget to look at the rating assigned by rating agencies before investing in infra bonds. All bond issuers have to go through rating process before they can raise debt.
  • Finally, understand the risk associated with bond investment. While the nature of a fixed return looks risk free, it exposes the investors to interest rate risk and inflation risk. Inflation at the rate of 10 percent will essentially give you negative returns on a bond that offers 9 percent returns.
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