By Umang Papneja
Indian Union Budget 2021-22: When I started my wealth management career at the turn of the century, RBI bonds were the easiest investment option we as wealth managers would provide to HNIs. There were two types – one was the 8% taxable bond and the other being the 6.5% tax-free bond. Clearly, the concurrent presence of tax-free and taxable bonds is not new. Back then, investors were drawn to the tax-free option and could easily distinguish between the two in terms of their respective value proposition. Even today, the tax-free bonds issued by PSUs, at the start of the last decade, trade at 4.5% while taxable bonds of the same PSUs, and same residual tenor, trade at 6.5%. The tax-free bonds, over the years, generally trade at 100-150 bps lower than their taxable counterparts. Today, as we stand at the cusp of the next normal, and redesign strategies and policies in the aftermath of the COVID-19 pandemic, we must envisage innovative and holistic solutions.
In the backdrop of such an environment, a simple solution to be considered in the upcoming Union Budget would be to issue a separate series of tax-free government securities (G-Secs). Let’s take an example to see what happens if the government borrows through tax free bonds from individuals, in dematerialized form and lists these securities on the stock exchanges:
- It significantly reduces the cost of borrowing: Going by current market yields on previously issued tax-free bonds, new tax-free issuances can help the government reduce its interest cost by approximately 20-25% for the next 10-15 years. Interest cost as a percentage of GDP can remain stable as borrowings rise in the aftermath of the pandemic.
- No meaningful impact on the tax collections on coupons paid: G-Secs are mostly purchased by provident funds and insurance companies, which essentially do not pay tax on investment income. Mutual Funds also invest in G-Secs and the investor pays reduced tax as tax is computed on indexed gains. Retail participation is negligible. Consequently, the total tax earnings arising from the coupons paid by these bonds are relatively minuscule for the exchequer.
- Enable retail participation: The government securities market could tap into the pool of savings of an entirely new segment of individual investors. Moreover, this would provide retail investors with a safe and value-accretive investment option. Previous tax-free bonds, issued by PSUs more than a decade ago, collected more than 1 lakh crores. Today, the number could be significantly higher.
Government Securities can be issued by the central government or by state governments. The state government issuances are called SDLs. Tax-free issuances can also help state governments lower their cost of borrowings. In the current fiscal, states have borrowed 42% more than the borrowings in the corresponding period of 2019-20. The average SDL borrowings so far in 2020-21 have been slightly more than Rs. 14,000 crores every week. Further, in a recent release, the Reserve Bank of India, in consultation with the State Governments/UTs, announced that the quantum of total market borrowings by the State Governments/UTs for the quarter January – March 2021, is expected to be Rs. 3.16 lakh crore. Clearly, the ask from the states’ perspective is yet to be holistically met.
In an environment, which is yield-starved, coupled with lack of fixed income deployment options for investors, tax-free government securities will be a win-win for both the government (lower cost of borrowing) and individual investors (core allocation of tax free bonds as a part of their fixed income portfolios).
(Umang Papneja is the CIO of IIFL Wealth Management. The views expressed are the author’s own.)
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