Pvt Banks to Offer Tax-Free Core Bonds

India’s private banks and non-banking finance companies (NBFCs) appear set to join a list of select stateowned firms which will be allowed to offer tax-free bonds to investors, as the government seeks to broaden its avenues to raise long-term funds to build more roads, ports and power plants. The country will need over a trillion dollars over the Twelfth Plan period (2012-17 ) to improve its infrastructure.

Finance minister Pranab Mukherjee said that given the constraints in financing key projects, the government has decided to open up the window for issuing tax-free infrastructure bonds to private firms also. So far, only state-owned companies were allowed to issue such bonds.

In this year’s Budget, Mr Mukherjee has proposed that investors could put money in tax-free infrastructure bonds over and above the ceiling of Rs 1 lakh for specific investments such as in the public provident fund and equity-linked savings schemes. Investors who park funds in the proposed infrastructure bonds will get a tax break of Rs 20,000 annually. However, the bonds are expected to have a long tenure in excess of 10 years.

Private sector banks and NBFCs, particularly those providing finance to infrastructure sector, may be among the beneficiaries of the latest move, a finance ministry official who did not wish to be named told ET. The Indian central bank, or the RBI, recently introduced a new category of NBFCs — ‘Infrastructure Finance Companies (IFCs)’ which will be largely lending to the infrastructure sector. These specialised NBFCs are tipped to be the first off the block in this bond issuance. The cost of funds raised through infrastructure bonds is low, as the rate of interest offered is low, but the effective return to investors is high because of the tax benefits.

A number of governmentowned entities have issued tax-free bonds at 7.5%. If a private sector entity floats such bonds, the cost could work out to 8-9 % which is still lower than raising money from banks at close to 11%,” said Vishwas Udgirkar, executive director at consulting firm PricewaterhouseCoopers. In the early half of the decade, infrastructure bonds were a hit with investors, but changes in laws in Budget 2005-06 made them less attractive and practically killed the retail market for such bonds which was worth Rs 15,000-20 ,000 crore then. In a way, Mr Mukherjee appears to be reversing the policy pursued during the time of his predecessor, P Chidambaram, when tax-free bonds were discouraged.

Institutions such as the state owned Rural Electrification Corporation were regular issuers, earlier managing to raise funds at 6% rate. Only institutions like the government-backed IFCL now issue tax-free bonds that are picked up by institutional investors. The Budget announcement was in keeping with the demand of banks that sought access to such bonds to lend to the infrastructure sector. Infrastructure projects, typically, need debt for 15-20 years, but banks do not have access to long-term funds, as the deposits they raise are of shorter duration.

Banks can raise five-year deposits that are eligible for tax deduction . The benefit will be available to taxpayers after the passage of the finance bill and subsequent notification of the provision by the finance ministry. The move to allow private players to issue infrastructure bonds will also help in the development of a long-term bond market that now lacks both depth and liquidity. However, experts said this may just be the first step, and more measures would be required to generate retail interest.

“Infrastructure sector is stretched for capital and this move will open one more big avenue for borrowers to raise fund from retail . To create appetite for such bonds and deepen the market, these bonds could be sliced into two categories based on their level of risk. One category could be to raise funds to finance new projects and other one by securitising cash flows from existing infra projects which will be more secure,” said Jai Mavani, head, real estate and construction, KPMG. Deepening of the bond market will require more participation from pension funds, said experts, something which the finance minister did not lose sight of on Tuesday.