With interest rates likely to fall and stock markets hitting new highs, its time to look at debt instruments like tax free bonds
Interest rates likely to fall
There is a possibility that interest rates are likely to fall and hence it is a good idea to stay invested in debt for a longer term.
If for example, an investor invests for in a bank fixed deposit say for a period of one year at 9%, chances are, if he decides to renew the deposit after one year, he might get a lower interest rate then is currently prevailing. Therefore, it is advisable to place the fixed deposit for a long term period like three to five years.
While it is difficult to predict interest rates trends with 100% accuracy, indicators point out to the fact that interest rates may have peaked out and a dip is imminent.
Inflation, one of the key variables in interest rates movement has been falling. When inflation drops, the Reserve Bank of India (RBI) tends to ease the monetary policy by reducing interest rates. Also, economic growth tends to slow down during a high interest rate regime and slowing growth is a cause for concern, which sometimes forces policy makers to reduce interest rates.
Therefore, with lower inflation and slower economic growth rates, it is likely that the Reserve Bank of India might reduce interest rates going forward, which makes it an attractive proposition to lock investments in long term debt instruments like tax free and infrastructure bonds.
Tax free bonds
To save tax, and to stay invested for the long term the best investment would be tax free bonds. These are excellent instruments to lock money for the long term at reasonably high interest rates and also save tax at the same time. These bonds are for a duration of 10 to 15 years, hence one is able to lock amounts for the long term and hedge against falling interest rates. The current coupon rates range from 8 to 9% and with tax savings, the post tax savings yields are significant.
Many of these bonds including the infrastructure and tax savings bonds closed their offerings recently, including HUDCO, IDFC, National Highways Authority and Indian Railways Finance Corporation.
While it is now not possible to purchase infrastructure bonds, it is possible to purchase tax free bonds from the exchanges. For example, the National Highways Authority bonds are listed on the National Stock Exchange. The income from these bonds are tax free and would not form a part of the total income.
The National Highways Authority Bonds are currently traded between Rs 1030 and 1040, against the issue price of Rs 1000 per bond. There fore those who purchase these bonds from the market would have to pay Rs 30 to Rs 40 more. But even after paying more for those who are in the 20 and 30% tax the yield still works out to rates that are better then bank rates.
For those who have missed the various bonds that came up in the last few months, there might be another opportunity as Rural Electrification Corporation plans to come out with tax free bonds in March. The company plans to raise Rs 1500 crore, with an option to raise another Rs 1500 crore.
If the Rural Electrification's bonds offer a coupon rate of around 8.30 to 8.80%, it might be an excellent investment opportunity.