Is it a wise move to invest in infra bond?

The government of India has outlined a plan to spend $1 trillion in next 10 years on infrastructure development. This development is necessary because infrastructure needs support to sustain the projected growth rate of Indian economy for next few decades.

To fund this initiative, the government is trying to tap the various sources at its disposal. Infrastructure bond is just one source where the government has given tax breaks for up to Rs 20,000 for individuals. This is to attract retail investment.

On individual front, infrastructure bond is widely welcomed by salaried individuals who have been demanding to increase the tax break from 1 lakh.

It has given them another avenue to invest for tax saving purpose. But, there are more tax saving investment options available for investors. Let's take a look at other investment tools that provide fixed income.

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Debt oriented mutual funds

The other debt instruments available for investment are debt oriented mutual funds. These funds allocate major part of the fund in government securities, corporate bonds and debentures, and sometimes in fixed deposit. They can be a good alternative.

However, even though they are debt oriented funds, a small part (up to 30 per cent) goes towards equity. Hence investors tend to see fluctuation in returns.

The average returns from debt oriented funds over a period of time can be about 12 per cent depending upon the market condition and proportion of fund invested in equity.

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Bank fixed deposit

The other option is banks where the rate of interest has gone up. Some banks give good returns on fixed deposits. For example, Bank of Baroda gives 10 per cent returns on fixed deposit. This is certainly better returns in absolute term.

The post-tax returns will be about 7 per cent. There are other banks which offer similar rates on fixed deposits.

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Corporate fixed deposit

Then there are fixed deposits offered by blue chip companies. These are highly rated debt instruments. For example, Mahindra Finance or Tata Motors deposits are two prominent offers that offer 10.25 per cent returns.

Mahindra fixed deposit scheme is rated FAAA, the highest rating. The payment is done quarterly.

There are other firms which offer even better returns but those firms rated lower. Investors should consider these alternatives too.

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Fixed maturity plan

There are mutual funds, also known as, fixed maturity plans (FMP). They are as good as fixed deposits and offer an "expected" return of 9 to 10 per cent.

We say "expected" because there is always the risk of corporate default (though it rarely happens).

Hence all the options look better till you consider the tax advantage that the infrastructure fund provides you. Tax advantage is the biggest advantage that infra bonds provide. The interest received on infra bond is taxable though.

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Investors' response

Infrastructure bond has received a very good response from retail investors for tax saving purpose. The demand goes up before the end of the financial year.

Even though it is a big hit among salaried individuals and retail investors, it did not impress big ticket investors in India and abroad. This is because they are more focused on getting better returns than saving tax.

To encourage response from FII, government is planning to reduce the lock in period of infra bonds. The lock-in period currently is five years.

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In all probability, this may come down to one year. The reduced lock-in period may be able to bring foreign capital for infrastructure projects which are delayed because of lack of funds.

Ideally, reducing the lock-in period should bring more investors, both domestic and multinational. This seems to be a good way to increase participation and transaction. However, the downside of this is that it will increase speculative investment.

Retail investors anyway invest in infra bonds to save taxes and hence there isn't much scope left in retail segment.

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In conclusion:

First, you must invest in infra bonds because you will save taxes. There is no other way you can save taxes on Rs 20,000 extra.

Do not invest more than Rs 20,000 as the tax benefit is limited to just Rs 20,000. Any investment beyond this will be taxed as usual. The disadvantage of infra bonds is the lock-in period and the taxable interest.

Second, look at the rating assigned by rating agencies before investing in infra bonds. All bond issuers have to go through rating process before they can raise debt.

A high rating such as AAA or even AA is good and implies the capability of the company to pay the interest and principal.

Finally, understand the risk associated with bond investment. While the nature of fixed return looks risk free, it exposes the investors to interest rate risk and inflation risk. Inflation at the rate of 10 per cent will essentially give you negative returns on a bond that offers 9 per cent returns.