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Investors should use the opportunity to invest in new bond issues as interest rates may fall going ahead

 


Tax-free bonds have caught the investor imagination lately. Housing and Urban Development Corporation's (HUDCO) tax-free bond issue has raised Rs 2,405 crore when it closed on October 14. According to market participants, new issues from Power Finance Corporation (PFC issue is currently open) and National Hydroelectric Power Corporation (NHPC) are likely to mop up even bigger amount from retail investors. However, amid the euphoria — 8.92% tax-free interest for 20 years — there is a bit of confusion among retail investors. Many of them are wondering whether they should wait for a few more days or weeks for new issues with even higher rates.


For example, many investors were extremely eager to subscribe to HUDCO bond issue when it opened a month ago, but had second thoughts about the issue when PFC announced that it was offering 8.92% for 20-year term. Suddenly, the coupon of 8.76% for 15-year tenure that HUDCO offered looked too little. Now, NHPC also has matched the interest rates offered by PFC and investors are — well, to put it mildly — greedy. They would like to take their chances and would like to wait for better returns. However, investment experts are busy asking their clients to put their money in the on-going issues. Do not wait for higher interest rates. You should lock-in your money in the ongoing tax-free bonds as the interest rates may move down gradually. And institutional and high net worth investors, are seen subscribing to his views. On the first day of PFC issue, it got bids worth Rs 2,332 crore against the maximum issue size of Rs 3,875 crore.



You don't have to base your investment decisions on others in the market, but a look at the macro-economic factors indicate a possible fall in interest rates. RBI has reduced interest rates on marginal standing facility to banks to 9% from 9.5% recently. Put simply, banks can now raise funds for a period of up to 14-days at 9%. Market participants believe this is the first step towards unwinding of all strict measures that RBI has taken to stop the fall in the rupee. If this theory holds, you may see tax-free bond issues with lower interest rates in future.


It is true that short-term rates may take cues from such events and head downwards soon; long-term interest rates may take some more time as inflation expectations continue to be moderate. For September, wholesale price index, a gauge of inflation, stood at 6.46% against 6.1% in August, primarily due to high food prices. However, experts bank on inflation tapering off in coming months.


Towards the end of the year, we should see food prices going down due to arrival of new crops, which should partly address food inflation. Another major component of inflation has been the rising prices of LPG and diesel, which many believe would be halted because of the upcoming elections. Though a hike in key rates by RBI in October cannot be ruled out, market participants believe the long-term rates should start falling in the medium term.


We cannot ignore the dwindling growth. IIP numbers for August stood at 0.6%. As US dollar stabilises against the rupee, RBI's focus should shift to boosting growth and it will gradually start reducing interest rates. As and when RBI decides to bring down interest rates, the coupon on the forthcoming tax-free bonds may not be as high as PFC and NHPC.


As the interest rates start their movement downwards, borrowers may decide to wait for a while before hitting the market with their new issues. This may deprive you an opportunity to invest at higher rates, experts say. Borrowers would be keen to issue bonds at lower interest rates.

What should be Your Strategy?

These bonds are very good investment options for retired individuals. They can simply buy and hold these bonds to enjoy timely taxfree income. They are a good option for even those in active service, to earn taxfree returns. Also, it is assured for a longer period of 15 to 20 years.


You may choose to invest in staggered manner. Invest a major chunk of your investible money in both PFC and NHPC. Do not wait for the last day of the issue as it may be subscribed early, even in the retail category. A small component of your money can be kept with you for future bond issuances if you are expecting even higher coupon, though most experts ascribe a very low probability to such a scenario. You can also play the interest rate cycle using 20-year bonds. If the interest rates fall by 100 bps over next one year, you will witness doubledigit capital gains on these bonds, in addition to the tax-free interest.

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