With the Reserve Bank of India slashing repo rate by 50 bps to 6.75% on Tuesday, investors who park their money in bank fixed deposits will stand to lose as lenders will now start reducing deposit rates. Risk-averse investors must now look at alternative debt options, such as small savings and tax-free bonds for higher long-term returns.
The central bank has cut repo rate by 125 bps since January. It has stressed that the onus is now on the government to remove impediments to transmission and for banks to pass on the rate cuts. Analysts expect the central bank to stay on hold until end of 2016 unless there is a significant positive surprise on inflation. Moreover, the government will review the small savings rates to facilitate transmission of RBI’s rate cut. This could bring down interest rates on small savings instruments, such as Public Provident Fund, post office deposits, National Savings Certificates, Kisan Vikas Patra, etc. So, where should investors park their money now?
Post office savings schemes
The Department of Posts operates Post Office Savings Schemes, which are quite popular with retail investors. The five-year and 10-year National Savings Certificates (NSC) offered by post offices are government guaranteed and a tax saving (under Section 80C of the Income-Tax Act) option for investors. The five-year certificates offer 8.5% interest rate compounded six monthly and payable at maturity. So, R100 grows to R151.62 after five years. Similarly, the 10-year certificates offer 8.80% interest compounded six monthly and payable at maturity. Here, R100 grows to R236.60 after 10 years.
The minimum amount that can be invested in NSC is R100 and one can buy certificates in denominations of R500, R1,000, R5,000 and R10,000. There is no limit for investment in this instrument. Under the Kisan Vikas Patra, which was re-introduced in November 2014, the amount invested doubles in 100 months. This means KVPs would give a return of 8.7% annually.
The five-year Monthly Income Scheme (MIS) of post office is one of the popular investment instruments among those looking for a regular income every month. On a single account, one an invest up to R4.5 lakh — up to R9 lakh in case of a joint account — and it gives a return of 8.4%.Those who want to invest in the monthly interest income can open a recurring deposit account for five years, which will give an interest of 8.4% per annum compounded quarterly. One can give instructions to the post office to automatically transfer the interest income of MIS to the post office savings bank account and, then, to the recurring deposit account.
Post office time deposits also pay more than bank deposits. One-year post office time deposits would fetch 8.4% and a five-year deposit will fetch 8.5% per annum compared to 7.25% in SBI deposit for 3-5 years.
Public Provident Fund is also one of the most popular small savings schemes offering 8.7% with a maturity period of 15 years and can even be extended within one year of maturity for a further five years, and so on.
Retail investors can earn higher returns in tax-free bonds. These bonds will be issued by top seven state-owned companies to raise R40,000 crore this financial year. In fact, NTPC’s tax-free bonds issued in August were oversubscribed 7.25 times. For retail investors, they are offering a return of 7.36% for 10 years, 7.52% for 15 years and 7.6% for 20 years, payable annually. Power Finance Corporation will offer tax-free interest of up to 7.6% per annum. The issue will open on October 5 and close on October 9. Others, such as NHAI, IRFC, Hudco and REC, will hit the markets soon. In these bonds, while the investor does not get any tax exemption under Section 80C of the I-Tax Act, 1961, the interest accrued is completely tax-free under Section 10(15)(iv)(h). It is mandatory for subscribers to furnish their Permanent Account Number to the issuer of the bond.
There will be a ceiling on the coupon rates based on the government security rates for equivalent maturity. A triple-A rated issuer can sell the bonds to retail investors at a rate which is 55 bps lower than similar-maturity government bond yields and 80 bps lower in case of other investor segments. Any AA-plus rated state-owned company can offer an additional 10 bps above the ceiling rate for AAA-rated entities and any AA or AA negative rated entity will sell bonds paying additional 20 bps above the ceiling rate for AAA-rated companies.
Only public sector companies can issue such tax bonds. The proceeds from the bonds are invested in infrastructure projects. Retail investors, which comprise individual investors, Hindu Undivided Family (through Karta) and Non-Resident Indians, can invest up to R10 lakh in each issue. An individual can invest in more than one company and still be in the retail category. Individual investors investing more than R10 lakh will be classified as high net worth individuals. About 40% of the public issue will be earmarked for retail individual investors. Investors do not have to pay tax on the interest earned on such bonds, which makes them more attractive than other taxable debt instruments and even bank fixed deposits.