There are a deluge of tax free bonds in India, that are looking to raise money. A few of them have already been successfully completed, while a few others like HUDCO are in the pipeline.
Tax free bonds are bonds that offer you interest income that is tax free in India.
However, there are some demerits or disadvantages of tax free bonds. Some of these are as follows:
1) Early over subscription
Most of these tax free bonds, at least these days, tend to get over subscribed really fast. Most of the time it is on the same day. What this means is that those applying for large amounts may not get allotment. This can be a major disappointment with tax free bonds.
Let's cite an example. If you are looking to invest as much as Rs 10 lakhs and the bonds were oversubscribed heavily, you may end-up getting allotment for only a smaller amount, as an example only Rs 2 lakhs.
2) Not very liquid
Tax Free bonds are listed on the stock exchanges, but, they may not necessarily be very liquid. Most of the time the quantity traded is very low. What this means is that if you want to purchase say large quantities or sell large quantities, you may get stuck.
Today, as we are checking there is a buy quantity of just 100 in the HUDCO Tax free Bonds Series 3. So, if there is an individual, who has been allotted 1000 bonds he would be able to sell the same only after a week or so. This is a big disadvantage of tax free bonds in India.
3) Risk of rise in interest rates
Since you are investing in tax free bonds at a fixed interest rate, you run a big interest rate risk. This is because these bonds have a duration of 10, 15 and 20 years. If there is an increase in interest rates, the prices of the bonds tend to fall.
4) Long tenure of tax free bonds
The long duration of these bonds also makes them a little disadvantageous. Duration of 10, 15 and 20 years is rather long.
Despite the demerits of the tax free bonds in India, they are extremely popular, especially among high networth individuals in India. If you are in the highest tax bracket, these are a better investment bet, than taxable instruments like bank deposits.