It’s raining tax-free bonds. Close on the heels of the Power Finance Corporation (PFC) issue which opened last Monday, National Hydro Electric Power Corporation (NHPC) launched its bond issue on Friday. The rates being offered by NHPC are the same as those by PFC. Retail investors (those who invest up to Rs 10 lakh) will get 8.43 per cent interest annually on the 10-year bonds, 8.79 per cent on 15-year and 8.92 per cent on the 20-year instruments. These are the best rates on tax-free bonds so far this year.

With rates on tax-free bonds issued by public institutions linked to Government security (G-sec) yields, it is an opportune time to lock into tax-free bonds. The yield on the 10-year G-sec after peaking at around 9 per cent in the recent past has moderated to 8.55. But this is still close to the highs seen during the financial crisis of 2008 and a sharp rise in yields from current levels seems unlikely. So, rates on tax-free bonds issued later this fiscal year may not match current levels.

Investors across tax slabs with a long term horizon can consider investing in the 20-year bonds. Those in the higher tax slabs (20 per cent and 30 per cent) can also invest in the 10-year and 15-year instruments. There is no tax payable on the interest on these bonds, which you will receive annually. The returns on the NHPC and PFC tax-free bonds beat those on bank deposits. Five-year bank deposits currently offer a best rate of 9.5 per cent, which compounded quarterly works out to 9.84 per cent. But after considering taxes, the return on the bank deposit falls to 8.83 per cent for investors in the 10 per cent tax slab, 7.82 per cent for those in the 20 per cent tax slab and 6.8 per cent for those in the 30 per cent slab. This is lower than what the tax-free bonds offer.

NHPC or PFC?

Both NHPC and PFC are Government-controlled entities. NHPC operates in the hydroelectric power generation segment while PFC is an infrastructure finance company, dedicated to power sector financing. Both offer the same rates and are AAA rated, indicating the highest degree of safety. So, where should you invest? PFC seems to be the first among equals. It has demonstrated better consistency than NHPC in growing its profits.

The profits of both companies grew at a compounded annual rate of 22 per cent between 2009 and 2013. Even so, NHPC’s profit in 2013 was lower than that in 2012. PFC, on the other hand, has grown profits every year consistently. Also, PFC’s return on equity at around 18 per cent is more than double than of NHPC. So, you can give the first preference to the PFC issue. But, if you miss the PFC bus, hop on to NHPC.

But before you invest in the tax-free bonds, keep aside funds for your public provident fund (PPF) investment. PPF not only offers good tax-free returns (8.7 per cent currently) but also gives you a tax deduction on the initial investment up to Rs 1 lakh. This makes the effective return on the PPF higher than that on the tax-free bonds which do not provide any tax deduction on the initial investment.

>anand.k@thehindu.co.in

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