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Singh Doubles Tax-Free Bonds in Blow to Projects: India Credit

Indian Prime Minister Manmohan Singh
Manmohan Singh, India's prime minister. Photographer: Jock Fistick/Bloomberg

June 14 (Bloomberg) -- Prime Minister Manmohan Singh’s drive to double tax-free bond sales risks a glut that will make infrastructure borrowers pay a premium over government debt for the first time, according to India’s biggest underwriter.

Top-rated National Highways Authority of India and Indian Railways each plan to sell 100 billion rupees ($1.8 billion) by March and may pay as much as 25 basis points more than benchmark rates, according to Axis Bank Ltd. National Highways last sold the notes in January to yield 8.2 percent, or about 7 basis points less than 10-year sovereign debt, data compiled by Bloomberg show. Borrowing costs for AAA rated Chinese companies average 4.86 percent, according to Chinabond indexes.

India’s government is pushing state-run borrowers to sell a record 600 billion rupees of tax-free notes this fiscal year to revitalize economic growth, which was the slowest in nine years in the first quarter. Singh outlined proposals last week to put $6.3 billion into port projects and build 9,500 kilometers (5,904 miles) of roads in the coming year as part of India’s plans to spend about $1 trillion on infrastructure by 2017.

“If the entire amount of tax-free bond supply is to be absorbed, it will have to be at a significant spread,” Parthasarathi Mukherjee, Mumbai-based president of treasury and international banking at Axis, said in a telephone interview June 11. “The rate outlook doesn’t suggest a sustained drop in benchmark rates.”

Growth Constraint

Lack of adequate infrastructure in Asia’s third-largest economy is a constraint to India’s growth, Finance Minister Pranab Mukherjee said in his annual budget speech to parliament on March 16, when he announced the increased issuance of the bonds, which exempt buyers from taxation on interest payments.

“Investors want to cover risks from fundamentals and market developments,” K. Ramanathan, chief investment officer in Mumbai at ING Investment Management Pvt., a unit of the largest Dutch financial services company, said in a telephone interview June 8. “Tax breaks and other such options can help issuers ensure availability of funds.”

India last year built an average 4.5 kilometers of roads a day against a target of 20 kilometers, according to a PricewaterhouseCoopers LLP study. The national highway system, a predominately two-lane network linking major cities, carries 65 percent of India’s freight and 80 percent of passenger traffic.

National Highways’ finance chief J.N. Singh in New Delhi could not be reached on his cell phone. Indian Railway Finance’s Managing Director Rajiv Datt didn’t respond to two calls to his office in New Delhi.

Bond Quota

“The parameters for us and investors have changed alike from our last issuance, as we have to take into account developments like firm inflation, a weakening rupee, and the fiscal situation,” Hari Das Khunteta, finance director of Rural Electrification Corp., a lender to power projects, said in a telephone interview from New Delhi on June 12. “The cost of tax-free bonds will differ from last time as they have to account for the present macro-economic conditions.”

The company hasn’t decided on the timing of its tax-free issuance this year, he said. The government will allow power companies, including Rural Electrification, to sell 100 billion rupees of the debt by March.

The borrower paid a yield of 7.93 percent on 10-year notes and 8.12 percent for 15-year debt when it raised 30 billion rupees in March.

India’s rupee weakened 8.7 percent in the fiscal year that began April 1, the worst performance among Asian currencies. The rupee dropped 0.1 percent to 55.75 per dollar at 12:52 p.m. in Mumbai, according to data compiled by Bloomberg.

Inflation Quickens

The government today said inflation accelerated to 7.55 percent last month from 7.23 percent in April and 6.89 percent in March. The median estimate of 37 economists in a Bloomberg News survey was 7.5 percent.

Elsewhere in the markets, yields on 10-year government bonds have dropped 17 basis points since April 17 when the Reserve Bank of India lowered the benchmark interest rate to 8 percent. The yield on the 8.79 percent note due November 2021 was little change at 8.29 percent today, according to the central bank’s trading system.

The extra yield investors seek for top-rated corporate five-year rupee debt compared with similar-maturity government notes widened 17 basis points in May, the biggest monthly gain in at least a year, according to data compiled by Bloomberg. The spread was 117 basis points, or 1.17 percentage points, yesterday.

’Not in Favor’

“Non-sovereign debt is not in favor among investors given the weak global and domestic environment,” Mukherjee at Axis said.

The cost of protecting State Bank of India debt against non-payment rose 0.2 basis point yesterday, having increased 43 basis points in the past month to 374 basis points, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

State Bank is regarded as a proxy for the nation in the market. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Demand for the tax-free bonds may also pose “a bit of a challenge” as regulations restrict companies from buying debt at yields below the official bank rate, according to Yes Bank Ltd. The bank rate was increased as a technical adjustment to 9.5 percent in February, from 6 percent earlier. The rate has stood at 9 percent since April.

“It is too much of supply too soon, because there is a lot of supply from the previous year still floating around,” Nirav Dalal, head of debt capital markets in Mumbai at Yes Bank, said in an interview yesterday. “The authorities need to tweak the regulation restricting corporates, otherwise demand may be muted.”

RBI Decision

Reserve Bank Governor Duvvuri Subbarao will cut the repurchase rate by 25 basis points to 7.75 percent next week to support economic growth, according to 14 of 18 economists in a Bloomberg survey. High inflation levels may still prevent policy makers from reducing rates, according to CLSA Asia-Pacific Markets and Kotak Securities Ltd.

“We also have to keep in mind that there are inflation pressures,” Deputy Governor Subir Gokarn said in response to questions from reporters in Mumbai June 5.

The government allots companies a quota of tax-free bonds they’re allowed to issue. In the financial year ending March, National Highways, Indian Railways and Indian Infrastructure Finance Co. can each sell 100 billion rupees of the notes while Housing and Urban Development Corp Ltd., National Housing Bank, and Small Industries Development Bank of India can offer 50 billion rupees. Port operators can raise as much as 50 billion rupees and power companies have a 100 billion-rupee allocation.

“Any offering has to cover more than the cost for an investor, which in this case is high inflation,” Ashish Sable, vice-president at SBI Capital Markets Ltd., said in a telephone interview from Mumbai on June 11. “The total quantum offered is still very high and there isn’t enough demand.”

To contact the reporters on this story: Anoop Agrawal in Mumbai at; Jeanette Rodrigues in Mumbai at

To contact the editors responsible for this story: Sandy Hendry at; Shelley Smith at

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