NTPC tax-free bonds: worthy buy for investors in higher tax brackets

After several private placements over the past few months, the first public issue of tax-free bonds for 2015-16 opens on Wednesday — power generator NTPC is leading the charge. Retail investors (those investing up to ₹10 lakh) will get 7.36 per cent, 7.53 per cent and 7.62 per cent, annually, on the 10-, 15- and 20-year bonds, respectively. Other investors will get 0.25 percentage points less across the tenures. Interest on these bonds, which will be paid out annually, is exempt from tax.

Those in the higher tax slabs seeking long-term, safe avenues can consider investing. Here’s why. One, NTPC’s tax-free bonds are rated ‘AAA’ indicating the highest degree of safety for investors. Next, the returns are better than what banks offer on their fixed deposits.

Bank deposits vs NTPC bonds At the upper end (currently about 8.5 per cent compounded quarterly), bank fixed deposits give investors post-tax returns of about 7 per cent (in the 20 per cent tax slab) and 6 per cent (in the 30 per cent slab). This is much lower than the tax-free rates on NTPC’s bonds. But the bonds don’t make sense for those in the 10 per cent tax slab, since bank deposits fare better with their post-tax returns of about 7.9 per cent.

For those in the higher tax slabs though, it seems prudent to lock into NTPC’s bonds rather than wait for the other tax-free bond issues which will hit the market over the coming months. It is likely that the issues in the future may offer lower rates.

Rate cut scenario The interest rates on tax-free bonds are linked to those on government securities (G-Secs). The rates on G-Secs have fallen sharply over the past year and may go down further. A rate cut by the RBI, if it happens, in the upcoming monetary policy, may be a trigger for this.

NTPC’s regulated returns model provides good revenue visibility; the expected growth of the power sector in the country should help the company. Also, its debt-to-equity ratio, at about 1.2 times, is at comfortable levels.

Compared with the 8.6-8.9 per cent offered by NTPC on its tax free bonds a couple of years back, the rates on offer now may seem quite low. But this is a function of the interest rate cycle which is on a downward curve. As it stands, NTPC’s tax-free bonds score very well as a safe investment option for those in the higher tax slabs. The issue size is ₹700 crore of which 40 per cent (₹280 crore) is reserved for retail investors. Though the issue closing date is September 30, the bonds will be allotted on a first-come-first-served basis and the issue could be closed earlier when it is fully subscribed. The minimum investment amount is ₹5,000 (five bonds of ₹1,000 each).

PPF option But before investing in these tax-free bonds, keep aside funds for your public provident fund (PPF) investment.

With good tax-free returns (8.7 per cent currently), PPF provides tax deduction on the initial investment of up to ₹1.5 lakh, making it a superior investment.