The tax-free bond issue of Rural Electrification Corporation (REC) offers an attractive opportunity for you to lock into low risk and superior tax-free interest income when compared with fixed deposits as well as post office schemes.
The 10-, 15- and 20-year bonds are available at 8.26%, 8.71% and 8.62% per annum respectively for both domestic and non-resident retail investors. For NRIs it is available on a repatriable and non-repatriable basis. The bonds are available for issue in both demat and physical form. Click here to buy through your FundsIndia account.
The rates are arrived at by reducing 55 basis points (for retail investors) from the reference G-Sec rates, as stipulated by laws governing these issues. It is noteworthy that the above rates are for retail investors (investment up to Rs 10 lakh). These rates are higher than the coupon offered for institutional and HNI category.
REC’s tax-free bonds are bonds on which the interest income does not suffer tax throughout the tenure. There is no tax benefit (such as 80C) on the principal. Most debt options, barring the PPF and EPF suffer tax on the interest component. Your FDs, post office schemes and corporate deposits are no exceptions.
In the case of REC, the coupon rate is actually the post-tax return for you. This makes these classes of bonds attractive for most tax payers.
Added to this, government security yields have been on a rise since July, thanks to the depreciating rupee. As tax-free bonds have to take in to account the G-Sec rates for reference, the current REC bond rates are higher than rates offered last fiscal. Currently 10-year G-Sec yields are at about 8.79% (close of Aug 29).
The 10 and 15-year coupon rates of similar bonds from REC issued in December 2012 were 7.72% and 7.88% respectively.
REC will issue Rs 1000 crore of bonds with an option to raise another Rs 2500 crore (totaling to Rs 3,500 crore), through this issue. At Rs 1000 a bond, the minimum subscription is Rs 5000. Interest will be paid out every year on December 1.
Low risk, high return
Coming from a Government of India Undertaking and granted AAA (highest credit rating) by multiple rating agencies including Crisil and ICRA, the tax-free bond is ideal if you are looking for a steady flow of income.
The table below shows the effective interest rate from bank deposits for a 10-year deposit available at 8.75% (rate offered by PSBs and others on an average). The yield on an 8.75% deposit works to 9.04% as the interest in compounded quarterly with FDs.
Clearly, the bond is tax-effective for all investors who pay tax irrespective of the slab in which they fall under.
REC is a public financial institution under the Ministry of Power, Govt. of India. It provides financing to all segments of the power sector, including power generation projects as well as independent power projects.
The company enjoyed lower cost of borrowing (as of FY-13) compared with peers and has adequate capitalization done by the government. It can also issue long-term infrastructure bonds besides tax-free bonds to raise money.
All its bonds are AAA rated. For FY-13, it total income (net of interest expense) was Rs 5590 crore up 35% over the previous financial year. Profits after tax rose 12% to Rs 3820 crore for the same period.
As mentioned earlier, the bond is suitable if you are looking for regular sources of income. Even if you do not need the money, with some amount of discipline, you can ensure that you reinvest the interest income in short-term debt funds or income funds, based on your time frame. You can consider the 10 or 15-year option as they provide superior returns.
While these bonds can be sold in the stock market (you will incur capital gains), considering that the market for them is illiquid and you need to time your exits well, you may be better off holding the bond till maturity.
The offer closes on September 23. The company may choose to pre-close it.