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Tax-free bonds issued by State-run infrastructure financial companies over the past six years are listed on the BSE and the NSE, and traded actively. Many tax-free bonds are available at a yield-to-maturity (YTM) close to 6.5 per cent and good liquidity.
Quasi sovereign guarantee
Since these entities are backed by the government, the investments made in tax-free bonds enjoy capital safety. Further, the bonds issued by most of these companies are rated ‘AAA’ by CRISIL, ICRA, India Ratings and CARE. Instruments with ‘AAA’ rating are considered to have the highest degree of safety with regard to timely servicing of financial obligations.
Investors in the highest tax bracket, including retirees, who are looking for capital safety and decent returns can consider buying these tax-free bonds from the secondary market and hold till maturity.
Among these, those issued by the Rural Electrification Corporation (REC) look attractive. They are actively traded on the BSE and the NSE with relatively higher YTM and liquidity. REC was permitted to issue tax-free bonds in FY12, FY13, FY14 and FY15. It has totally issued 21 series of tax-free bonds.
Four series of REC tax-free bonds, with YTM of 6.4-6.6 per cent, are traded actively in both the exchanges. For instance, the REC N9 series (ISIN INE020B07HS2) — with a coupon rate of 8.71 per cent and residual maturity of 9.7 years — trades with a YTM of 6.48 per cent on the NSE.
Since the interest paid by tax-free bonds are exempt from income tax, the current yield of 6.48 per cent translates to 9.3 per cent of pre-tax yield for investors in the 30 per cent bracket. This makes it a more viable option than bank fixed deposits for retail investors. Currently, public and private sector banks offer 6-8 per cent pre-tax interest rate for five-year FDs.
HDFC securities data show that each of the four series of REC tax-free bonds have been trading with good liquidity. Higher liquidity helps you buy or sell the bonds at the desired price and quantity. Further, these bonds are available with a residual maturity of 4.7-16.9 years. Investors can buy the bonds that match their investment time horizon.
Retail investors can buy and sell tax-free bonds through a demat account. Keep in mind that 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 REC
REC is a Navratna central public sector undertaking under the Ministry of Power. It is one of the leading infrastructure finance company. The company plays a pivotal role in financing power projects from both the State and private sector.
The Centre is the major shareholder with an ownership of 58.32 per cent equity shares as of March 31, 2018. REC’s gross and net NPAs were 7.92 per cent and 4.28 per cent, respectively, as on September 30, 2018.
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