Millennium Post

The name is bond, tax-free bond

The bonds, meant for infrastructure project funding by large PSUs, proved to be a success to the great relief of both the issuers and the government although they clashed to a good measure most of the commercial banks’ year-end plans to mop up fixed deposits to meet the usual additional busy season fund demands from industry, agriculture and services sectors. The total bond issue target by 13 PSUs in the current financial year was Rs 48,000 crore. The notable among those large PSUs are Indian Railway Finance Corporation (IRFC), India Infrastructure Finance Company (IIFC), Rural Electrification Corp (REC), Power Finance Corp (PFC), Housing and Urban Development Corp (HUDCO), National Housing Bank, National Highway Authority of India (NHAI), NTPC and NHPC Limited.

 However, what is a matter of real concern is that not many of these PSUs are ready to deploy the bond proceeds immediately in projects for various reasons, including non-availability of several necessary government clearances. Only those projects, which are progressing at fast pace, are capable of sucking up such large funds within the next two months or so. Funds left idle with PSUs will attract an average 8.50 annual interest payable to investors. This will raise the ultimate cost burden of these funds, cost of projects and the question of their viability. Ethically, these funds can’t and shouldn’t be diverted to other schemes or programmes to earn higher cash returns. The government has already sacrificed good amounts in direct tax on interest income of investors from these bonds and will continue to do so in the next 10 to 20 years.

Interestingly, investors in PSU bonds are mostly those having declared annual taxable income of Rs. 5 lakh and above and fall under the tax slabs of 20-30 per cent. The real beneficiaries are those falling under the tax slabs of 30 per cent and above. The average annual return from 7-10 year bank fixed deposits is 8.6 per cent whereas average annual yield from tax-free 10-year PSU bonds is 8.39 per cent. It makes sense to invest in these bonds by those paying higher rates of income tax, that is 20 per cent and above. At post 20 per cent tax, the net annual yield from bank FDs is 7.9 per cent. And, for those paying 30 per cent income tax, the annual yield from bank FDs shrinks further to 7.2 per cent, making investment in tax-free PSU bonds truly attractive. The government stands to lose roughly Rs. 1,000 crore annually in direct tax revenue if computed under the perspective of the current bank interest rates on FDs.

However, it is not the government’s loss or gains from the tax-free PSU bonds that is the only concern of the economy or the society. If the inflation comes down to five or six per cent resulting in lower banks rates, the high-cost bond-embraced PSUs stand to lose substantially on account of debt servicing. The only way out is quick utilization of the bond proceeds and fast completion of those designated projects which, in turn, can start earning fast – on schedule or ahead of schedule.

Therefore, the project implementation holds the key to ultimate success of these bond issues. The bond issuers must ensure that the projects, funded by the high interest loans, are completed in time to pay back. This poses the biggest challenge before most of these infrastructure and core sector PSUs as many of the projects had, in the past, failed to maintain their respective phased deadlines for variety of reasons. There are others who have been forced to slow down projects due to lack of demand from downstream users or beneficiaries.

Historically, large public sector enterprises have been the worst performer when it comes to keeping project implementation schedule. The time overrun invariably leads to massive cost overrun. The practice breeds corruption as the contractors-suppliers insists on renegotiation for higher rates. External factors such as imports often became costlier and even local inputs, finance and labour costs dearer. Almost all steel, coal and power projects, including generation and transmission, ran well behind their original schedules. Among the biggest culprits in this regard were nuclear power plants, hydro-electric and thermal power projects, railways, highway construction, government housing projects, etc. For instance, the vizag steel plant, initially projected to cost only around Rs. 700 crore within a three-year gestation period, had ultimately took some 15 years for completion, costing close to Rs. 20,000 crore. The contractors and suppliers were the biggest immediate beneficiaries of the project.

For the first time, sovereign wealth funds (SWFs) have been allowed to invest in the private placement segment of these bonds. Private placements were earmarked up to 30 per cent of the issue. Subscription by SWFs was meant to bring more dollars into the country somewhat ignoring the fact that a high current account deficit and almost a 30 per cent fall in the value of rupee will add to the nagging problem of foreign debt servicing.? Half the tax-free bonds are from three large state enterprises They are: IIFC and IRFC,  Rs 10,000 crore each, and PFC Rs 5,000 crore. They were also asked to raise dollars by issuing additional quasi sovereign bonds of $4 billion (over
Rs 25,000 crore).

The NHAI, HUDCO and REC would raise Rs 5,000 crore each. NHAI had failed to issue Rs 10,000 crore of bonds last year, though it was sanctioned. This time, its annual interest yield on bonds came to 8.53 per cent, 0.04 per cent higher than what IRFC offered. The National Housing Bank and Ennore Port, which could also not raise the sanctioned amount in 2012-2013, saw a cut in their sanctioned bond size to Rs 3,000 crore and Rs 500 crore, respectively. Jawaharlal Nehru Port Trust and Dredging Corporation of India have not been allowed to raise bonds this year. Other companies allowed to issues the bonds are NTPC (Rs 1,750 crore), NHPC and Indian Renewable Energy Development Agency (Rs 1,000 crore each), Airports Authority of India (Rs 500 crore) and Cochin Shipyard (Rs 250 crore). Now that the bond issue is more or less over, project monitoring must receive the highest priority. Those responsible for project implementation delays should be identified and penalised. Otherwise, a good part of the bond proceeds will go to private contractors’ pocket as it happened in the past.

Without naming them individually, it could be said that most private sector mega engineering and construction firms of the day owe their existence, growth and prosperity to the time and cost overrun in large PSU projects.

The entire economy and society are bearing the burden of the inefficient project handling by the state sector.

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