Recently, the government announced the launch of its floating rate bonds with 7.15% coupon rate. How attractive is the product and should investors really be enthused enough to investing in these floating-rate bonds?
Replacing the 7.75% bonds
In a way, the new 7.15% floating rate bonds are a replacement for the 7.75% taxable bonds that were discontinued. However, the 7.15% bonds are a tad more complicated in that they entail payment of floating rates of interest. The rate will begin with 7.15% for the Jan-21 tranche but every 6 months these rates will be reset based on the prevailing interest rates in the economy. The bonds will have a tenor of 7 years and the interest on these bonds will be entirely taxable. These bonds will have a face value of Rs.1000.
Beneficial when rates go up
Since the bonds are taxable, the only key takeaway for the investors is if the yields move higher. At the current rate of 7.15% for Jan-21, if you factor in 30% tax, then you are left with post-tax returns of just about 5%. The only hope is that if the interest rates move up then these floating-rate bonds could be at an advantage for investors while other such schemes will not benefit from rising rates of interest. In the extreme event of yield hardening, this could be a good choice, although that appears remote.
Blowing hot and cold
There are a couple of clear advantages to these bonds. Firstly, it is an issue of the government of India and hence it ranks very high on the safety ranking. The default risk on such a bond is zero. As long as the interest rates do not fall very sharply from these levels, these floating rate bonds can be a very attractive proposition for the investors. However, if rates were to correct by another 200 bps from these levels, then these bonds would hardly be attractive in post-tax terms. There are also some practical disadvantages to these bonds. These bonds will not be traded so there is no exit route for investors. Secondly, these bonds are not accepted as collateral for loans so the liquidity potential of these bonds is also fairly limited.
Still prefer debt fun
The question is whether investors should really look at locking in their money for seven years in a floating rate bond. If you consider longer-term debt funds, the yields have been in excess of 8%. Debt funds structured as SWPs can be more tax-efficient compared to floating rate bonds, which are subject to tax at the peak rates applicable. Also, the debt funds are more likely to benefit from falling interest rates (a more likely scenario in Indian bond markets). On considerations of returns, tax smartness, and liquidity, debt fund would clearly score over floating rate bonds!
