RV COLLEGE OF ENGINEERING
R.V.Vidyaniketan Post, Bengaluru-560059
ESTIMATION AND COSTING
Topic: INFRASTRUCTURE BOND-BRIEF
DESCRIPTION
SUBJECT CODE : 16CV73
Submitted by
NAME: CHANDAN D
USN: 1RV17CV027
SECTION: A
Submitted to
Dr. ANAND KUMAR B
Assistant Professor
DEPARTMENT OF CIVIL ENGINEERING
R.V COLLEGE OF ENGINEERING
INTRODUCTION
Infrastructure bonds are bonds issued by infrastructure companies after they
have been approved by the government. The money invested in infrastructure
bonds is usually invested in the construction of infrastructures such as airports,
ports, roads and power plants.
According to Section 80CCF of the Income Tax Act, investments to the extent
of Rs.20,000 in infrastructure bonds qualify for income tax deduction, but the
limit is over and above the Rs.1 lacs deduction that individuals can claim under
Section 80C as they are long-term secured bonds that mature in 10 to 15 years.
The Industrial Finance Corporation of India(IFCI), Life Insurance Corporation
of India(LIC), Infrastructure Development Finance Company(IDFC) and any
non-banking financial institution recognized by the Reserve Bank of India as an
infrastructure finance company can issue infrastructure bonds. These bonds are
listed on standard exchanges like NSE or BSE so they can be bought through
these exchanges.
FEATURES
Eligibility
You need to be a Resident Indian to invest in this bond
Entry Age
No age limit is mentioned
Minimum Investment (Rs )
• Minimum: Rs 5,000
• Maximum: Rs 20,000 to avail tax deductions on investment
• Bond with face value of Rs 1,000 or Rs 5,000 issued depending on issuer
Interest
• 7.25 per cent to 8 per cent per annum depending on the issuer so far
Tenure
• 10 years
Account holding
• Individual
• Joint
• HUF
Nomination
• Facility is available
Infrastructure bonds are tax saving investments which offer tax exemption on
investments up to `20,000 under Section 80CCF in a financial year. These
bonds found prominence in Budget 2010 when they were introduced as an
additional avenue to save taxes and have a limited window for subscription
from time to time.
Investment Objective and Risks
The main objective of the infrastructure bond is to offer tax deductions on
investments up to Rs 20,000. Investments up to a maximum of Rs 20,000 in
these 10-year maturity bonds will be deductible from your taxable income under
Section 80CCF. This is over and above the tax deduction of Rs 1 lakh that one
can avail on savings and investments under Section 80C.
Capital Protection
The capital in the infrastructure bond is well protected.
Inflation Protection
The infrastructure bond is not inflation protected, which means whenever
inflation is above the interest rate offered on the bond; the return from the
scheme earns no real returns. However, when the inflation rate is below the rate
offered by the bond, it does manage a positive real rate of return.
Guarantees
The interest rate on the bond is guaranteed and varies across bond issuers and
the tenure of the bond opted for.
Liquidity
The infrastructure bond is completely illiquid during the first five years, unless
the bond holder dies. After the lock-in of five years, liquidity is offered in the
form of loan against the bond.
Credit Rating
The bond carries a credit rating which varies across bond issuers. So far the
bond has managed a high credit rating.
• The facility of pledging the infrastructure bonds in the first five years to obtain
loans is not permitted. After the five-year lock-in, the bonds may be pledged to
avail loans.
• Investors in the bond are allowed to exit only through the secondary market
after the compulsory lock-in of five years from the date of bond allotment.
• Investors can exit through the buyback route after 5 years depending on the
option provided by the bond issuer.
Exit Option
Premature termination of the bond is not permitted.
Other Risks
Fixed income instruments always carry interest rate risk. Increase in market
interest rates will have a negative impact on the price of the bonds. However,
the buyback option provided by the issuer allows the investor to redeem the
bonds at face value irrespective of the market price at which they are traded.
Infrastructure financing has inherent project specific and general risks besides
being exposed to regulatory changes, liquidity risks, risks of NPAs (non
performing assets), risk of volatility in interest rates and economic policy risks.
Tax Implications
Investments in the long term infrastructure bonds no more provide the tax
exemption of `20,000 under section 80CCF. This sum used to be over and
above the `1 lakh exemption available under section 80C.
Where to Buy the Bond
The bond can be bought from any of the bond issuers such as IFCI, IDFC, L&T
and others whenever open for fresh subscription. The bonds are also sold
through banks and brokers.
How to Buy
• You need to fill the form provided by the bond issuer.
• You will need your PAN number and demat account number.
• You can hold the bond in physical form if you do not have a demat account.
• Address and identity proof such as copy of the passport, PAN
(permanent account number) card, driving license, voter’s identity
card or ration card.
• Carry original identity proof for verification at the time of buying if
not already KYC compliant.
• A bond certificate bearing your name is issued if holding in physical
form.
Points to Ponder
• The interest received from these bonds are taxable
• Interest income is treated as ‘income from any other source’ and will
be added with the total income of the person and taxed as per the slab
in that financial year
• No TDS shall be deducted on the interest received if the bonds are
kept in demat form and shall be listed on NSE and BSE
There will be TDS for bonds if they are kept in physical form when
annual interest payout exceeds Rs 2,500 per annum.
Tips and Strategies
There are several ways to arrive at the yield and hence savings when
investing in these bonds. A simple way is to ignore all the
complicated analysis of yields and returns. Invest only if your
objective is to lower your income tax liability.
Going Online
The option to invest online exists during the investment period. Once
the bond is five years old, it can be traded online as well though the
demat account holding.
HOW GOOD ARE INFRASTRUCTURE BONDS FOR SAVING TAXES?
The Finance Minister, Mr. Piyush Goyal, had recently stated that India would
require close to $4.5 trillion in the next 10 years bringing Indian infrastructure
to Asian levels. Countries like China have invested trillions of dollars in
building roads, highways, airports, waterways etc and that has largely been
instrumental in helping China grow in the last 30 years. Poor infrastructure puts
a huge cost on economic growth and it is estimated that if India could bring
infrastructure to Asian levels then the annual rate of GDP would get a boost of
2% per annum. It needs to no reiteration that on a base of $2.6 trillion, that is a
lot of growth.
One of the big challenges in developing infrastructure is to create credible
means of financing the infrastructure. This calls for a robust debt markets and a
variety of innovative debt instruments to finance infrastructure. In the current
context, the government does provide options to issue special infrastructure
bonds with tax breaks to make them more attractive to investors. So, what
exactly are tax-saving infrastructure bonds and what are the benefits of
investing in infrastructure bonds? Above all, what are the conditions under
which I should invest in infrastructure bonds? Let us look at the 3 key
categories of infrastructure bonds that are available currently.
1. Tax free Infrastructure bonds
These are one of the most popular categories of bonds for financing
infrastructure. Companies that are into facilitating infrastructure in India are
permitted to issue these tax-free bonds. Typically, companies like Rural
Electrification Corporation (REC), National Highways Authority of India
(NHAI), and Indian Railway Finance Corporation (IRFC) are among the
institutions that are allowed to issue tax-free infrastructure bonds. In case of
these bonds the interest paid out on the bonds are entirely tax-free in the hands
of the investor. Effectively, it increases your post tax yield. For example, if the
tax-free bond is yielding 7% interest, then the actual yield on the bond
considering 30.9% tax will be
10.13% {7/(1-0.309)}. That is substantially better than what any bank FD can
give you. There is no other tax exemption available on these bonds other than
the tax exemption on interest payments. However, such bonds come with a long
lock-in period so you must be prepared for the illiquidity.
2. Capital Gains Exemption Bonds
This is another category of bonds issued by infrastructure companies. These are
capital gains exemption bonds where you can reinvest long term capital gains in
these bonds. Let us say you bought a property in January 2011 and sold it in
May 2018 and made a profit of Rs.40 lakhs. Now there be tax payable on long
term gains at 20% after considering the impact of indexation. Is there a way to
avoid paying this capital gains tax? The answer is to reinvest the capital gains
into Section 54EC bonds that are issued by infrastructure companies like REC
and NHAI. When you reinvest the capital gains on your property in these
Section 54EC Capital Gains bonds, then your capital gains become entirely taxfree. The only condition is that you have to invest the capital gains within a
period of 6 months from the date of the transfer of the capital asset to be eligible
for this exemption. The tax saved on capital gains is your added benefit on these
Section 54EC bonds, apart from the regular interest that you will receive. These
bonds typically carry a coupon interest of 6% and have a lock-in period of 3
years. Please note that the interest earned on these bonds is fully taxable in your
hands.
3. Special category Section 80CCF bonds
Infrastructure bonds were also eligible for exemption under Section 80C in the
past but the entire benefit was scrapped about 5 years back. In the Union Budget
2018, the Finance Minister re-introduced the exemption for infrastructure bonds
via a separate section called Section 80CCF. This Section 80CCF will give an
exemption of Rs.20,000 to the investors in the year during which the money is
invested in the bonds. While the Section 80CCF is a sub-section of Section 80C,
this exemption of Rs.20,000 is specifically for infrastructure bonds and is over
and above the Rs.150,000/- exemption limit that Section 80C offers. These
bonds will be subjected to a lock-in period of 5 years and the bond tenure is
normally up to 10 years. Again, the exemption is only for the contribution. The
interest component will continue to be taxable at your peak rate of tax.
Infrastructure bonds are like hitting two birds with one stone. Firstly,
infrastructure projects are able to raise funds for infrastructure at much lower
cost. At the same time for the HNI investors, this allows them regular income
which is tax free. Even for the taxpayer, this is an additional method of saving
on tax payouts. from June 2000 to March 2009 are selected. June 2000 is chosen
because data for equity infrastructure indices is available from this date and a
nine-year analysis period likely provides sufficient historical data
RETURN ANALYSIS OF INFRASTRUCTURE BONDS:
It is difficult to determine infrastructure bond returns because issuing firms and
projects do not classify bonds as infrastructure bonds and an infrastructure bond
index does not exist. However, Dailami and Hauswald [2003] analyze at-issue
spreads in a sample of 105 infrastructure project bonds from emerging markets.
This article utilizes the sample of bonds obtaining monthly bond pricing data
from Bloomberg for each bond over the life of the bond. Of the original 105
bonds, prices are available for 60 bonds, of which 59 are U.S. dollardenominated bonds which we use for return analysis. Exhibit 1 shows sample
descriptive statistics. Two bonds of the sample include call options and four
bonds (6.77% of the bonds) from Argentine issuers went into default during the
2000 crisis in Argentina but were restructured. Bonds are from 15 countries and
5 sectors. The transportation sector is poorly represented with one bond. Exhibit
1 shows at-issue ratings. These ratings show that the average bond is rated at the
lowest investment grade possible and most bonds are rated at the boundary of
investment and speculative grades. Using a numerical scale to represent credit
ratings with 1 representing AAA and 15 representing B shows that the sample
has an average rating of BBB- and a standard deviation of about three rating
grades. Exhibit 1 also shows the country risk based on ICRG rating scale, which
rates countries with the highest risk as 1 and the least risk as 100. The bonds
represent investments in countries with moderate risk, which is typical of
emerging markets. The low standard deviation in country risk also shows that
highly risky and highly safe countries are not part of the sample. The return
calculation begins by creating portfolios of infrastructure bonds. 1/n of the
portfolio is invested in each of n bonds following Fabozzi [1996]. The sample
comprises bonds that mature and are issued at different periods. When a bond
from the sample is issued, the endof-period wealth is invested in (n + 1) bonds
and when a bond matures, the end-of-period wealth is invested in the remaining
(n – 1) bonds. Therefore equal value weights are assigned for each constituent
bond, the investing strategy is a naïve buy and hold strategy, and portfolios are
not optimized. Short selling is not permitted and there are no cash outflows
from the portfolio. Cash coupons are added to the portfolio in the months that
they are received. Because bonds are issued and mature at different periods, the
process creates different portfolios. Portfolio returns are calculated following
Blume and Keim [1987] and Bessembinder, Kahle, Maxwell, and Xu [2009] as
follows:
EXHIBIT 1
Sample Descriptive Statistics
Since bonds are traded infrequently relative to stocks the data has missing
prices. Venkatesh [2003] assumes that investors receive a zero percent return
when the bond is not traded; i.e., the price is assumed to remain unchanged
from the previous period. Economically the assumption that investors receive
zero returns when bonds are not traded seems reasonable. It is, however, more
difficult to predict how this assumption affects portfolio variance. Constant
returns imply that individual bond variance likely falls, but portfolio variance
also involves covariance between the bonds. It is most likely that portfolio
variance is lowered by using this assumption. Exhibit 2 shows individual
portfolios’ risk and number of bonds plotted against portfolio beginning dates.
EXHIBIT 2 Portfolio Risk and Composition
Exhibit 2 shows the reduction in portfolio risk from diversification; portfolio
risk decreases as the number of bonds in the portfolio increases, as noted by
Fabozzi [1996]. Interestingly, Exhibit 2 also shows that portfolio risk begins to
increase from July 1997 until October 1998 even though the number of bonds
increases. This period coincides with the Asian financial crisis, which began in
Thailand and spread to almost all of Asia, particularly South Korea and
Indonesia in July 1997. The Russian financial crisis began in August 1998 and
recovery began in 1999. Portfolio variance also increases at the end of 2008
during the present financial crisis. We can conjecture that infrastructure project
bond portfolios dampen individual project and country-level risk factors, but are
affected by systemic factors affecting other asset classes. In order to compare
infrastructure bond risk returns and analyze correlations with other asset classes,
bond portfolios that do not overlap and provide a continuous stream of returns
from June 2000 to March 2009 are selected. June 2000 is chosen because data
for equity infrastructure indices is available from this date and a nine-year
analysis period likely provides sufficient historical data. Exhibit 3 shows
portfolio return, standard deviation, number of bonds, and months covered from
June 2000 to March 2009
CONCLUSION
Investors seeking infrastructure exposure through infrastructure project bonds in
emerging markets must consider the risk-reward profile of bonds, which is not
attractive in this article’s sample, although they outperform equities over the
period under consideration. However, infrastructure bonds have low correlation
with and show very stable cash flows compared to equities and equity
infrastructure indices. Infrastructure project bonds have a limited ability to
mitigate political risk, as compared to syndicated lending, which is likely
reflected in their low returns.