By IndiaHub 
Tax-free bonds, which were initially issued by public sector undertakings (PSUs) under government directives, gained traction as they provided investors with secure, government-backed returns without any tax liability.
“These came to be known as or are known as tax-free bonds because the interest is tax-free in the hands of the investor,” he said, underscoring the appeal of these bonds for those seeking tax-efficient investments.
The last issuance was in 2016, and since then, no new tax-free bonds have been issued. However, Aggarwal pointed out that the existing supply remains robust, allowing investors to still participate in these instruments.
“When they were done last in 2016, they were issued in large volumes and hence, there is sufficient supply in the market,” he stated.
Live Events
Why tax-free bonds?
One of the key advantages of tax-free bonds, as Aggarwal highlighted, is the favorable post-tax returns. While the interest rates on these bonds range from 5.5% to 6% tax-free, they are comparatively more attractive than fixed deposits (FDs) on a post-tax basis.
For instance, a 6% FD return is taxable, reducing the effective yield to around 4.2% to 4.5% for those in the 30% tax bracket. “Tax-free bond today is actually a far better investment option than an FD from a pure returns perspective,” Aggarwal emphasized, noting the significant post-tax advantage.
In terms of liquidity, tax-free bonds also stand out as they can be easily traded in the secondary market without penalties. “In the case of a tax-free bond, they are actually super liquid,” Aggarwal said, adding that investors can exit these bonds before maturity without facing a penalty, unlike FDs, which often impose a premature withdrawal charge.
Aggarwal also noted that in the current interest rate environment, where the Reserve Bank of India (RBI) has already implemented two rate cuts and is expected to lower rates further, tax-free bonds present an additional advantage of potential capital gains. “Investors purchasing tax-free bonds today will not only see interest but could see some capital appreciation as yields compress,” he said.
While new issuances of tax-free bonds have been halted, the possibility of reintroducing them remains uncertain. Aggarwal indicated that from the government’s perspective, issuing tax-free bonds involves a trade-off as it leads to a loss in tax revenue.
However, he suggested that the government could consider offering new tax-free bonds even at a lower interest rate, given their continued attractiveness as a risk-free investment option.
Who issues tax-free bonds?
Tax-free bonds, typically issued by government-backed entities such as NHAI, Rural Electrification Corporation, and others, carry AAA ratings, making them a low-risk investment option. “They do not typically see defaults. These are bodies like NHAI, Rural Electrification Corporation of India, and the likes. So, they are AAA rated, very secure instruments,” said Aggarwal, drawing attention to their stability and security.
How to invest in tax-free bonds?
Despite no new issuances, retail investors can still access tax-free bonds through three primary routes. First, they can reach out to their wealth managers or bank relationship managers, who may have access to these bonds.
Second, they can directly purchase these bonds through stock market platforms like Groww, Zerodha, or other brokerage apps. “You can actually try to buy these bonds directly in the stock market. Just open your Groww, Zerodha, whatever app you use and actually put in a request,” said Aggarwal.
The third option is through Online Bond Platforms (OBPP), where such bonds are periodically offered based on investor demand.
For retirees and those seeking passive income, tax-free bonds can be particularly appealing due to their relatively higher coupon rates. Aggarwal explained, “The coupon on these bonds is in the range of 8% to 9%, making the interest payout quite healthy and interesting for someone looking for passive income.” He provided a practical illustration: a Rs 10 lakh investment in a tax-free bond with a 9% coupon rate would yield approximately Rs 8,000 per month as interest income.
Also read: Will NaBFID successfully navigate offshore bond market?
For retail investors looking to enter the tax-free bond market, Aggarwal recommended exploring existing bonds from entities like NHAI and REC, readily available on brokerage platforms. With a minimum investment size of Rs 1,000, these bonds are accessible to a broad range of investors, offering a compelling combination of tax-free income, security, and liquidity.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)