Investment Focus: NHB tax-free bonds – Last and the best of 2013

Investors have been spoilt for choice in tax-free bonds in recent times, with issues coming up at regular intervals. Another attractive issue, this time from the National Housing Bank (NHB), opens tomorrow (December 30).

NHB, a housing sector regulator and financier, wholly owned by the Reserve Bank of India, is offering the best of both worlds. The bonds have the highest credit rating (AAA) and offer retail investors (those who invest up to Rs 10 lakh) the best rates so far on 15- and 20-year tenures.

The interest rates for retail investors on 10-, 15- and 20-year tax-free bonds stand at 8.51, 8.88 and 9.01 per cent, respectively. Interest will be paid annually.

15- and 20-year options ideal Investors can lock into the 15- or 20-year option as the rates are among the best one can get on fixed income options now. The tax-free nature of the interest income beats the returns offered by the closest competitor, a 10-year bank fixed deposit. The 9 per cent return offered on most such fixed deposits currently, diminishes to 8.35, 7.39 and 6.43 per cent for those in the 10, 20 and 30 per cent tax brackets, respectively (considering quarterly compounding and interest payout option).

Besides, yields on 10-year Government securities, to which the interest rates on tax-free bonds are linked, have crossed the 9 per cent mark only thrice in the last decade. While there could be another rate hike in January, the pause in the December policy meet indicates that the RBI is also taking the slowing economic growth into consideration in its policy rate decisions. So, a rate hike may not be a matter of course.

Also, with the market already factoring in an expected hike in January, the returns being offered by NHB may not be replicated in future issues. For example, similar ‘AAA’ rated tax-free bonds from the Indian Railway Finance Corporation, opening on January 6, offer slightly lower rates than NHB.

Timing the peak of the rate cycle is no easy task, and the returns on the NHB bonds seem to be as close to the peak as they can get.

HUDCO, whose tax-free bond issue is also open now, offers the same 9.01 per cent on the 20-year option. But the company’s bonds are rated ‘AA’, a notch lower than NHB’s bonds, making the latter a better choice.

Before investing in the NHB bonds, keep aside money for your public provident fund (PPF), a better investment option which not only gives tax-free returns (8.7 per cent currently) but also tax deduction on investment up to Rs 1 lakh a year. It is a good idea to re-invest the annual interest you get on the tax-free bonds in your PPF. This will help you build a good tax-free corpus for long-term goals.