Market bets on resumption of tax-free bonds for infra spend

MUMBAI: Debt markets in Mumbai believe North Block may consider the resumption of tax-free bonds to boost infrastructure spending amid talk that PSU borrowings used for building large projects had led to inaccurate projections of India’s fiscal gap.

"Infrastructure may have to find new ways for long-term financing," said Vishal Shah, partner at PwC. "You cannot have short-term money but at least 10-15-year money. For this, new avenues can be explored through tax-free bonds. Private sector capacity to fund is limited. That's why retail money could well be an option with tax-breaks."

In tax-free bonds, interest income is tax free, resulting in higher yield on interest income.


Last financial year, a group of state-owned companies raised Rs 65,000 crore by selling government-serviced bonds. Rural Electrification Corporation (REC), Housing and Urban Development Corporation (HUDDCO), National Bank of Agriculture and Rural Development (NABARD), and Power Finance Corporation (PFC) were among the large issuers.

In those papers, the government typically pays the interest due on behalf of the issuers. Critics argue that this is a way to “manage” fiscal deficit. Such borrowings reflect in the books of accounts of the issuing companies instead of those of the government.

The creation of physical infrastructure accelerated significantly during 2014-19, the pre-budget Economic Survey said Thursday. In April 2018, electricity finally reached every village in India, with efforts to link every home to the power grid still ongoing.

“The construction of national highways (NH) proceeded at a rapid pace, with more than 20% of the existing highway length of 132,000 km being constructed in the last four years alone,” the Survey said.

Tax-free bonds were introduced in 2012-13, selling debt of Rs 30,000 crore. The issuances extended in consecutive financial years until 2015-16, which saw about Rs 60,000 crore worth of bond sales.

Those bonds offered 9%. This time, if tax-free bonds are allowed, they would yield much lower, with overall interest rates falling. Those papers should offer rates in the range of about 5.50-6.50%.

“A new class of investors should be created for long-term infrastructure funding,” said Ajay Manglunia, managing director and head of institutional fixed income at JM Financial Products. “While the issuers gain on two counts – lower borrowing costs and long-term funding, investors find it relatively safe credit to higher cumulated interest income. Wealthy investors find them attractive as tax-free interest increases their cumulative interest income.”