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Buyers Strike Drives Yields for Tax-Exempt Bonds: India Credit

June 23, 2011

June 24 (Bloomberg) -- The builder of India’s state railway isn’t confident it can attract enough buyers for the nation’s first public sale of tax-exempt bonds to individuals because of rising interest rates.

Indian Railway Finance Corp. may fall short of the 80 billion rupees ($1.7 billion) it aims to raise this fiscal year on “a lack of appetite,” Managing Director Rajendra Kashyap said in an interview on June 22. The funding arm of the nation’s largest employer indicated a coupon of 7.5 percent on the 10- year debt. The yield on the tax-free 6.72 percent 2020 notes it sold to banks in November has surged 62 basis points to 9.56 percent this year, according to data compiled by Bloomberg.

“Tax-free bonds don’t make sense in an environment where interest rates are already very high and taxable bonds are giving higher returns,” Ritesh Jain, the Mumbai-based head of investments at Canara Robeco Asset Management Ltd. that oversees $2.2 billion in assets, said in an interview on June 21. “You have to time it well.”

A failure by Indian Railway to raise adequate funds will hamper efforts by Prime Minister Manmohan Singh, who has vowed to double spending to $1 trillion by 2017 to improve the nation’s roads, ports and bridges. The company’s borrowing costs are higher than the 5.32 percent yield on Daewoo Engineering & Construction Co.’s 2013 securities and the 3.37 percent rate on Canadian National Railway Co.’s 2019 notes.

Rupee Debt

Indian Railway, which plans to start selling the bonds in September, will offer an additional 20 billion rupees of the securities to institutional investors, Kashyap said. The National Highways Authority of India aims to raise 100 billion rupees by March selling tax-free bonds, J.N. Singh, the agency’s head of finance, said in an interview on June 6.

The tax-free structure underscores efforts by companies to attract investors amid a slump in local-currency debt offerings this year. Rupee notes sold by companies in the South Asian nation slid 35 percent to 674 billion rupees as the central bank raised borrowing costs by 125 basis points, or 1.25 percentage point, to 7.50 percent.

The yield on the government’s 10-year bonds rose by 35 basis points this year. The 7.8 percent notes due April 2021 dropped for a third day yesterday, with the yield climbing two basis points to 8.27 percent, according to the central bank’s trading system.

Investor ‘Resistance’

The difference in yields between India’s notes due in a decade and similar-maturity debt in the U.S. has widened to 536 basis points from this year’s low of 436 reached April 8. Rupee bonds returned 2.4 percent this year, compared with the 5.9 percent gain in Indonesian securities that was the region’s best performance, according to 10 Asian local-currency debt markets outside Japan monitored by HSBC Holdings Plc.

Chennai-based Shriram Transport Finance Co. plans to raise 10 billion rupees from a taxable debt offering that opens on June 27 with a coupon of 11.6 percent on five-year notes.

“If you knock off 30 percent tax on Shriram’s taxable bond, you’re talking of 8.1 percent returns,” said Arun Kejriwal, a Mumbai-based director at brokerage firm Kejriwal Research & Investment Services Pvt. “So there can be resistance to the IRFC issue because the yield is a little lower and they may have to do a little marketing.”

Offering exemptions doesn’t necessarily raise the allure of bonds as global investors have the ability to avoid paying tax, according to FirstRand Ltd., a unit of South Africa’s second- largest financial services company.

Reducing Hassles

“Global investors seem to be buying taxable bonds at 9.5 percent to 9.75 percent,” Krishnamurthy Harihar, a Mumbai-based treasurer at FirstRand, said in an interview yesterday. “To a foreign fund, a tax-free bond is of no use, because they get preferential treatment under double-taxation avoidance agreements.”

The cost of protecting the debt of government-owned State Bank, which some investors perceive as a proxy for the nation, has increased 33 basis points this year to 194, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

“The tax-free bond does have a market, even if it’s not the regular set of investors,” Ganti N. Murthy, who manages about $1.1 billion of assets as head of fixed income at Peerless Mutual Fund in Mumbai, said in an interview yesterday. “It’s the retiree’s instrument, good for those who wish to avoid the hassles of paying tax and filing returns.”

Inflation Consensus

India’s rupee has slid 0.5 percent this year, the second- worst performance among Asia’s 10 most-traded currencies. The currency dropped 0.1 percent to 44.9588 per dollar yesterday, according to data compiled by Bloomberg.

Demand for the tax-free bonds may remain weak as investors wait for the central bank to temper inflation, said FirstRand’s Harihar said. Wholesale prices index rose 9.06 percent in May from a year earlier after having climbed 8.66 percent the previous month.

“There is a consensus emerging that inflation is near the peak, but not there yet,” Harihar said. “People will want to buy maybe not today, but after one more round of hike.”

--Editors: Ven Ram,

To contact the reporter on this story: Karthikeyan Sundaram in New Delhi at

To contact the editor responsible for this story: Neil Denslow in Hong Kong at

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