Tax-free corporate bonds returning the equivalent of 13 percent are helping lure investors back as India’s debt market emerges from an unprecedented rout amid confidence in new central bank governor Raghuram Rajan.
Rural Electrification Corp. sold 10-year securities in late August at 8.01 percent, or about 180 basis points below regular notes. For buyers, the return is the same as that from taxable debt that pays 12.1 percent. National Housing Bank’s 15-year issuance offered the equivalent of a 12.8 percent yield. Both companies scrapped plans for conventional bond sales last month as borrowing costs surged amid a cash crunch created by the central bank to shore up the rupee.
State companies’ bonds with untaxed interest income offer the best combination of returns and safety now in India, where financial-market volatility surged last month to levels not seen since the global credit crisis, according to SBI Capital Markets Ltd. Top-rated five-year regular corporate yields fell 41 basis points in September to 9.82 percent, after climbing 197 basis points in the last three months in the biggest jump on record. A similar rate in China is at 5.19 percent.
“Tax-free bonds are offering possibly the highest returns and are appear to be the best safeguard against the volatility in financial markets at present,” Ashish Sable, Mumbai-based vice president at SBI Capital, a unit of India’s biggest lender, said in an interview on Sept. 6. “Conventional investment modes may offer returns that don’t entirely cover the risks of inflation and the implications of weaker rupee.”
India has allowed 13 state companies to offer a record 480 billion rupees ($7.5 billion) of debt without levies this fiscal year, a finance-ministry circular obtained by Bloomberg News last month showed. The government is encouraging such issuance to fund a plan to attract as much as $1 trillion in investments by 2017 to improve infrastructure ranked worse than Kazakhstan and Guatemala by the World Economic Forum.
The program is a “huge success,” according to Edelweiss Financial Services Ltd., with investors seeking to lock in the high returns as secondary-market yields fall from recent highs. The rate on 10-year government bonds has dropped 79 basis points from an Aug. 19 peak of 9.23 percent on optimism the RBI will succeed in restoring financial stability.
Governor Rajan, who took charge on Sept. 5, signaled steps to make it easier for banks to swap dollar deposits, curb bad debt and boost lending. Credit-default swaps insuring the bonds of State Bank of India, a proxy for the sovereign, against non-payment for five years have fallen 39 basis points from a 14-month high of 372 on Aug. 20, according to data provider CMA.
“Investors are aware that yields may not sustain at these high levels and so, they are grabbing the opportunity to invest in tax-free bonds,” Ajay Manglunia, head of fixed-income at Edelweiss Financial, a Mumbai-based brokerage, in an interview yesterday. “The notes are offering a very attractive pricing.”
Rural Electrification, a state-controlled lender to power projects, raised more than 43 billion rupees in the past two weeks selling untaxed securities to institutional and individual investors. Power Finance Corp. borrowed 11.2 billion rupees and National Housing got 9 billion rupees. India Infrastructure Finance Co. picked up 30 billion rupees, while Housing & Urban Development Corp. sold 1.9 billion rupees of debt.
Indian Railway Finance Corp., the financing arm of the state rail network, and India Infrastructure Finance can raise as much as 100 billion rupees each, according to the finance-ministry document. Housing & Urban Development Corp., Rural Electrification, Power Finance Corp and National Highways Authority of India can offer as much as 50 billion rupees each.
“Investor outlook on tax-free instruments is positive as these are being issued by public sector companies and offer competitive post-tax returns,” R.V. Verma, New Delhi-based managing director at National Housing Bank, said in an interview on Sept. 6. “There is good appetite for these notes as these are tried and tested instruments, offer a good lock-in rate for the long-term and are highly rated, thereby ensuring safety.”
A government plan to market tax-free bonds to international buyers may fall short of expectations because foreigners pay smaller local levies than domestic buyers, according to Edelweiss’s Manglunia. India will allow investors including sovereign wealth funds to invest in such debt for the first time, according to the finance ministry document.
“Foreign investors have to pay 5 percent withholding tax, making little difference between investing in tax-free and taxable debt,” said Manglunia. “The Indian investor is in the 30 percent tax bracket, so it makes a huge kicker for them.”
Global funds have pulled $8.8 billion from rupee debt since the end of May, exchange data show. The Indian currency lost 13.9 percent this year, the worst performance in Asia after Indonesia’s rupiah. The rupee was little changed today in Mumbai at 63.835 per dollar, according to data compiled by Bloomberg.
“Tax-free bonds are long-tenor investments, and foreigners prefer short-term securities,” said Manglunia. “Only if the currency stabilizes and confidence is restored, we may see sovereign wealth funds and overseas investors invest a little bit in these securities.”
The success of untaxed debt sales by state-controlled firms that build or finance infrastructure projects would boost fund availability for new roads, power plants and ports in India, helping spur growth in an economy that expanded 5 percent in the year ended March 31, the least since 2003.
“The yield levels are encouraging for investors and a strong subscription would go a long way in giving a boost to the economy as a whole,” said Rupa Rege Nitsure, Mumbai-based chief economist at Bank of Baroda in a telephone interview yesterday. “It will be an encouraging development for the infrastructure sector, which has been sluggish for quite some time.”