Retail investors, who accorded a lukewarm reception to equity offers from Indian Oil Corporation and Coal India earlier this year, have queued up to apply for recent tax-free bonds from public sector entities. Power Finance Corporation and NTPC have seen their tax-free bond sales over-subscribed 11-12 times within hours of their opening. No doubt, savvy high networth investors are buying these bonds with an eye to pocketing some quick gains. With the Reserve Bank of India slashing its benchmark repo rate to 6.75 per cent last week, these bonds with yields of 7.3-7.6 per cent, are likely to list at a premium in the secondary market. But the reasons for the runaway response to these bonds from retail investors are entirely different. Small savers in India are literally starved of investment avenues that allow them to lock into a fixed income for a 10- or 20-year timeframe.
On paper, yes, commercial banks do offer 5- to 10-year term deposits. But savers are discouraged from locking money into such deposits because of low interest rates. Perversely, Indian banks offer much higher rates on their 2-3 year deposits than on their 5-10 year ones. Then there is the taxation of interest at one’s slab rates. With tax breaks on almost all forms of interest income being withdrawn in recent years, returns of 7-8 per cent from debt instruments now translate into returns of just 5-6 per cent in the hands of the debt investor. The 15-year Public Provident Fund is a reasonable option, but the annual cap on investments and procedural difficulties put many investors off. Given this, it is hardly surprising that retail investors flock to any highly rated long-term bond, even if the yield barely matches long-term inflation.
The scramble for tax-free bonds should serve as an eye-opener to policymakers. Instead of focussing on wooing small savers into equities, they should explore the bond route to channel household savings into nation-building. For starters, government-backed entities such as Indian Railways and NHAI can explore retail bond issues to meet their prodigious capital needs. The Centre and the RBI also need to do more to promote direct retail participation in the primary and secondary market for g-secs (government securities). Though a retail quota in primary g-sec auctions was initiated with much fanfare years ago, it has not drawn much response. Most retail investors remain unaware that they can actually participate in these auctions. The requirement to route their bids through primary dealers has proved a stumbling block as well. Ideally, retail investors should be able to transact in g-secs through the same online trading platforms that they use to bid electronically for public issues or offers for sale. With domestic interest rates reversing, informed investors — insurance firms, pension funds and foreign institutions — are rushing to buy Indian g-secs. There is no reason why domestic small savers should be denied this money-making opportunity.