One of the PSU Navaratna companies, REC has come out with a tax free bond issue for collecting funds of Rs3500 crores (including the green shoe option). This is the first issue out of the 12 odd issues expected from various PSUs over the next 6 months or so. The tax free bonds are available in tenures of 10 years, 15 years and 20 years. NRIs can also apply for these bonds with repatriation and non-repatriation benefits.
These bonds have been rated “AAA” by all the credit rating agencies meaning that the principal and interest would be serviced on time by the borrower. This is the highest of the credit ratings available for any bond issue.
Coupon - Category IV (Retail)
10 year - 8.26%
15 year - 8.71%
20 year - 8.62%
The above rates are for retail investors who subscribe less than Rs10 lakhs. For all other category of investors, it is 25 basis points less than the retail interest rates. Considering the recent spike in Government Bond yields, the investors are lucky to get higher tax free interest rates.
Interest would be paid out on 01 Dec every year during the tenure of the bond.
The rates on tax free bonds from PSUs are determined by the Finance Ministry based on the G-Sec yields prevailing two weeks before the issue date. The Finance Ministry has allowed the PSUs to offer yields up to 55 bps less than the prevailing G-Sec rates to ensure that these issues don't fail as few of the previous tax free bond issues last year and early this year.
As these are tax free bonds, there is no tax payable by any investor. These tax free bonds are also a very useful tool to transfer wealth to spouse or others without attracting the clubbing provisions under Income Tax act. As the income from REC Tax free bonds are exempt from tax, there is no clubbing provision applicable for investors.
We recommend investing in this tax free bonds from REC and you may either choose the 10 year or 15 year option depending on your time horizon. It is an excellent product to add to your debt portfolio towards long term goals like retirement planning or children education.
Investors across all tax slabs can invest, though investors in the lower tax may be better off investing in Bank FDs at current rates.
This is suitable for all types of investors as there is no volatility in returns compared to debt mutual funds.
The issue closes on 23rd September. If you are planning to invest, it is better to do it earlier as the retail portion has been already seen subscriptions of above 50% in 2 days.
What are the points you have to note before investing in this bond?
Not a cumulative product: The important point to be noted here is that these bonds have annual interest pay-outs. That is, REC would pay annual interest and you have to find ways and means to deploy the interest to further grow it. If you don't have PPF account, it would be a good option to open a PPF account and move the annual interest directly to the PPF account.
For somebody who is willing to take some risk, they can invest the annual interest in good quality debt or equity mutual funds.
As there is a flood of Tax free bonds which are expected over the next 6 months, the investors may get more options to invest in tax free bonds. It is also possible, that the newer issues from other PSUs may have higher interest rates. But it is very difficult to predict how the interest rates would move for the forthcoming tax free bonds in 2013.