Over the past few months, quite a few instances of credit-quality downgrades and defaults in the bond market have jittered fixed-income investors. Capital safety has now become a prime concern for most investors. At this juncture, investors looking for debt instruments that provide capital safety and decent returns can consider tax-free bonds available in the secondary market. Tax-free bonds issued by State-run infrastructure finance companies over the past six years are listed on the BSE and the NSE, and traded actively. Among these, the ones issued by the Power Finance Corporation (PFC) look attractive.
Since these entities are backed by the government, the investments made in their tax-free bonds enjoy capital safety. Further, the bonds issued by most of these companies are rated with the highest grade of ‘AAA’.
PFC issued tax-free bonds in FY12, FY13, FY14 and FY15. Totally, it has issued 18 series of tax-free bonds. According to data compiled by HDFC securities retail research, three series of tax-free bonds, with a yield-to-maturity (YTM) of 5.6-6.3 per cent, are traded actively on the BSE.
For instance, PFC 892PFC33 series (ISIN: INE134E07463) — with a coupon rate of 8.92 per cent and residual maturity of 14.8 years — trades with a YTM of 6.3 per cent on the NSE.
The interest paid by tax-free bonds are exempt from income tax. Hence, the current YTM of 6.3 per cent translates to 9 per cent pre-tax yield for investors in the 30 per cent bracket. This seems to be a better deal for retail investors than bank fixed deposits. Currently, public and private sector banks offer 6-8 per cent pre-tax interest rate for their five-year FDs.
These three series of PFC tax-free bonds have been trading with a daily average volume of 300-600 units over the past one month. Further, these bonds are available with a residual maturity of 3-14.8 years. Investors can buy the bonds that match their investment horizon.
Retail investors can buy and sell tax-free bonds through a demat account. Selling tax-free bonds in the secondary market attracts capital gains tax. If you sell these bonds within 12 months from the date of purchase, you will have to pay tax on the gains as per your tax slab. If you sell after 12 months, tax has to be paid at a flat rate of 10 per cent. No indexation benefit is available.
About PFC
PFC was established in 1986 and is one of the government-owned financial institutions that provide financing exclusively to the power sector, including for thermal, hydro, nuclear, wind and solar power generation; transmission and distribution; and renovation and modernisation of existing projects.
The Centre remains the majority shareholder in PFC. The government supports the company financially and operationally in various ways, including conferring special status to raise capital gains tax-exempt bonds.
PFC is the largest lender to the power sector with a share of over 20 per cent, and plays a key role in channelling finance to PSUs. As of September 30, 2018, PFC’s tier-I capital adequacy ratio (CAR) was 14.9 per cent, overall CAR was 17.9 per cent, and networth was ₹38,274 crore.