REC 8.71% Tax-Free Bonds Issue – August 2013

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

Rural Electrification Corporation (REC) will be launching the first public issue of tax-free bonds for the current financial year from 30th of this month. The company is offering quite attractive interest rates to the retail individual investors with 8.26% for 10 years, 8.71% for 15 years and 8.62% for 20 years. These rates are higher by approximately 0.70% to 1.50% as compared to the rates offered last year.

REC plans to raise Rs. 3,500 crore from this issue, including the green-shoe option of Rs. 2,500 crore. Though the official closing date of the issue is September 23rd, I think the issue should get closed before that due to oversubscription.

The government has allowed REC to issue Rs. 5,000 crore worth of tax-free bonds this financial year and the CBDT notification has mandated a minimum of 70% of this amount to be raised from public issues. As the issue size is Rs. 3,500 crore, if it gets fully subscribed this time itself, I think REC would raise rest of the money through private placements only and it will become the last issue of REC this financial year.

NRIs, QFIs & “Retail Individual Investor” – Non-Resident Indians (NRIs) on repatriable as well as non repatriable basis and Qualified Foreign Investors (QFIs) are also eligible to invest in this issue. The scope of a retail individual investor, investing upto and including Rs. 10 lakhs, has got broadened with the introduction of NRIs and QFIs (as individuals). It includes Hindu Undivided Families (HUFs) also through the Karta.

So, the investors have been classified into the following four categories:-

I – Qualified Institutional Bidders (QIBs) – 20% of the issue reserved

II – Non-Institutional Investors (NIIs) – 20% of the issue reserved

III – High Net Worth Individuals including HUFs, NRIs & QFIs – 20% of the issue reserved

IV – Retail Individual Investors including HUFs, NRIs & QFIs – 40% of the issue reserved

Interest Payment Date & Record Date – As this question gets asked by many of the investors throughout the year, it is better to mention it here itself as the date is known in advance this time. Interest will be paid on December 1st every year and the record date will be 15 days prior to that.

No Cumulative Option – There is no option of taking cumulative interest at the time of maturity with these bonds. Interest will be paid annually.

Safety, Ratings & Nature of Bonds – Being a ‘Navratna’ PSU, REC offers a high degree of safety as far as your investment is concerned and that gets reflected in the ratings assigned to this issue. The issue has been rated ‘AAA’ by four rating agencies, CRISIL, CARE, India Ratings and ICRA. It is the highest rating given by each of these companies. Also, these bonds are secured in nature against certain assets of the company.

Listing – REC bonds will get listed on the Bombay Stock Exchange (BSE) within 12 working days from the closing date of the issue. Investors have the option to apply these bonds as per their choice, either in physical form or in demat form.

TDS & Minimum Investment – As these are tax-free bonds, there is no question of TDS getting deducted, whether you take them in physical form or demat form. Minimum investment required is Rs. 5,000 only i.e. 5 bonds of Rs. 1,000 face value each.

Interest on Application Money & Refund – REC will pay interest to the successful allottees at the applicable coupon rate and at 5% per annum to the unsuccessful allottees.

Tax Treatment on Sale – Listed bonds held for more than 12 months qualify as long term capital assets and if sold thereafter, would attract a flat 10% capital gain tax, without indexation benefit. However, if the bonds are sold prior to holding them for more than 12 months, then short-term capital gain tax would be applicable, as per the tax slab of the investor.

Key Attractions of these Bonds: There were many issues with the tax-free bonds issued last year. There was a huge difference between the interest rate paid to the retail investors and the interest rate paid to other investors. Also, the subsequent buyer from the secondary markets was to get a lower rate of interest. Moreover, the cut from the G-Sec rate was also set on a higher side.

I think most of those issues have got rectified this year. Here are some of the key attractions of these bonds this year:

High Interest Rates – Due to the falling rupee and the unsuccessful measures taken by the Government and the RBI to control it from further fall, the yields of the benchmark government securities (G-Secs), against which the coupon rates of these tax-free bonds get fixed, have risen sharply in the last 45 days or so. 10-year benchmark yield touched a high of 9.47% before falling sharply to 8.25%. Thanks to this jump, the company has been able to offer such attractive coupon rates, especially for the 15 years period.

A word of caution. 10-year benchmark yield has again jumped back to close at 8.78% on August 27th. If the economic fundamentals of the country continue to deteriorate at the same speed as they have been doing, the yields could keep moving higher and the rupee could keep falling further against the dollar. But, I still hope India would come out of the current crisis soon and as the macroeconomic things get stabilised, these rates would look highly attractive again.

High Interest Rates, even if bought from the Secondary Markets – As per the CBDT notification – “The higher rate of interest, applicable to RIIs, shall not be available in case the bonds are transferred by RIIs to non retail investors”. So, the interest rates earned by the retail individual investors this year would remain higher even if they buy these bonds from the secondary markets subsequent to the offer period.

Your eligibility for a higher rate will depend on the number of bonds held in your name on the record date and the same will get tracked by your PAN number. Your holding should not be more than 1000 bonds per issue on the record date to get higher rate of interest.

Till last year, only the first allottees were eligible for a higher rate of interest and the subsequent buyers from the secondary markets were supposed to get a lower rate of interest. This factor will encourage the retail investors to participate in the secondary markets and thereby result in higher liquidity.

Low Differential – The differential between the rates offered to the retail individual investors and the other categories of investors has been cut down to 25 basis points (or 0.25%) only, as compared to last year’s 50 basis points (or 0.50%). This is the best step that has been taken this year. This factor would attract higher participation from the other categories of investors, both during the initial offer period as well as in the secondary markets.

I honestly think that these tax-free interest rates are very attractive. If I compare these rates with the interest rates on bank fixed deposits, the rates look quite similar, but with huge difference of tax applicability. I seriously hope India’s macroeconomic picture should start looking better in the days to come, only then we will be able to enjoy these high rates, otherwise inflation would again eat up all fruits of our hard work.

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