Tax Free Bonds: Better than NRE FD’s

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Yes, you read it right! Tax free bonds are better than NRE Fixed deposits.

After all these years of recommending NRE FD’s as the safest bet for investing in India, I am changing my recommendation to Tax free bonds (in no particular order) by IREDA, NHAI, NABARD, REC and HUDCO.

Lets compare the bonds to the NRE deposit

1. NRE Fixed usually give the highest rate for a lock in of 2 or 3 years and are averaging between 7.8% to 8.2%, which means that the reinvestment on maturity would be at the prevailing interests rates.
2. NRE deposits have a penalty in case of pre mature withdrawal
3. Interest on NRE deposits is tax free

A Tax free bond on the other hand is giving a 7.64% for a period of 15 years (NABARD which opens tomorrow – 9th Mar 2016) in retail category (less than 10 lacs) or half a percent lesser for amounts exceeding 10 lacs.

You must be wondering why am I recommending the bonds when they give lesser interest and are tax free like the NRE FD? The Central Bank interest rates across the world are going down and India has already had a few rate cuts which makes these Bonds attractive. As the interest rates will be reduced the value of these bonds will increase (capital appreciation) . These bonds are more liquid than a FD as they are traded on the stock exchanges which means that one can sell the bond without incurring pre mature withdrawal penalty in case of FD. Further for a slightly lesser interest rate these bonds let you lock in a higher interest rate for next 15 years.

If this has not convinced you then let me tell you the most important reason why I am recommending these bonds – interest on NRE FD’s becomes taxable if a NRI returns to India. Depending on the individual residency criteria in section  6 of the Income Tax of India on return a NRI becomes a Tax Resident in 6 months to 2 years, upon which the NRE accounts are converted to a Resident Rupee Account, which means that any interest that accrues on your NRE account after you become tax resident becomes taxable.

These bonds on the other hand assure tax free income for next 15 years from the date of allotment.

Now the fine print – not all bonds are open to NRI’s for investment, however if you have a resident bank / brokerage account you could use that to apply for these bonds and / or purchase them from open market and benefit from capital gains and long term tax free interest income.

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17 thoughts on “Tax Free Bonds: Better than NRE FD’s”

  1. Hi Aditya,

    Would appreciate your suggestion for the following- I have a sum of money in US dollars held in DBS bank Singapore and need to transfer it to India for purchasing a property. Would it be preferable to transfer the sum as USD and convert the same in India or convert to Singapore dollars and then use DBS remit in Singapore to transfer to a NRE account in India.

    Thanks
    James

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    1. Hi James,

      If you use dbs remit you will be hit by double conversion.

      I was in a similar situation when I got 500K HKD in pension funds when I left my previous bank job.

      They best way to do it is withdraw the USD in cash from dbs branch, I went to mbfc branch. Then go to arcade money changer and tell them you have bulk usd to convert to SGD., they will give close to the spot rate. That is what I got. Then take the SGD and deposit it into your dbs account and remit to India.

      I also tried asking dbs the best rate to convert usd to SGD, but their best rate was also pathetic.

      This requires a little bit of daring to carry so much cash and go to arcade. But I did it and was thrilled with it 🙂

      Cheers

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    2. Hi James,

      I agree with Nitin’s suggestion. That is exactly what I have done as well. The exchange rates in change alley/arcade are the best specially for USD. The spread that DBS has for remittance is around 0.8%, SBI tends to have a 0.72% spread. For a larger amount you can ask them to check with their treasury department and you might get a spread as low as 0.5%.

      Hope this helps.

      Cheers

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  2. Hi Aditya!
    What is your opinion on the future of Deutsche Bank?
    I have over a crore invested in two FDs with them for a 5 yr tenure at an incredibly good interest rate of 10.46 compounded.
    However recently there has been increasingly bad reports on their future.
    Is the Indian Deutsche Bank branch safe?
    Should I withdraw all or part of my investment?
    What is your view?
    Regards!
    Danfer.

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    1. Hi Danfer,

      The decision to withdraw or leave the money in FD would depend on the remaining tenure…I am guessing the compounded 10.46% is around 8% annual which was probably around .25 percent more than other banks at the time of opening the FD. I would not know about safety of Deutsche India and personally prefer Indian banks because they have a higher probability of govt rescue in case things go bad.

      Thanks

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  3. I did a mistake of closing my posb account. I could have kept it as it has just a min balance reqt of $500. After opening OCBC 360 as my salary account, I thought posb is waste as ICICI money2india seemed to have a better rate in the past.

    Next time, for transferring, I will look at options other than ICICI.

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    1. You can always check the rates on the widget here on the site… I have consistently found dbs and SBI to have the best rates.

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  4. Hello guys, I just transferred using icici money2india and got a pathetic rate of 48.20 using their indicative rate. Their fixed rate is even worse 48.07. Current spot rate is 48.80. So that is a 60 pause spread. This is inspite of me being a NRI premia customer of icici. The customer care officer says premia customers get preferential rate on select currencies like AUD, GBP, CAD,USD etc but not for SGD.

    The do have promotions for new sign ups of 25 paise extra rate. And they make up for the loss by giving even bad deal for existing customers. This is really cheap tactics by icici.

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  5. Another point about the tax free bonds. It’s only an expectation that interest rates will fall and bond values will rise. But we know markets are markets and interest rates can actually rise from these levels and in that scenario bond values will fall and in that scenario you have no option other than holding them to maturity, which is 10 or 15 years. I am not sure if there is an early call option. Regarding trading on secondary market, not sure how liquidty is going to be.

    So NRE FDs make sense for those who are looking for safety above all else and for short term 2 yrs, you get 7.9% interest. Traditionally FDs are safest compared to bonds and are expected to give lower returns than bonds. NRE deposits have higher returns if you consider the tenure. So risk on risk NRE FD is the best.

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    1. Not all investments are for everyone Nitin and if people are not planning for long term investment then they can choose NRE FD’s or whatever else.

      With a NRE FD the basic assumption are:
      1. The person will remain a NRE for next 10 to 15 years. Because every NRE account would convert to regular account within 2 years of a NRI returning back to India and interest amount taxable. Given the general job scenario and market condition that is a big assumption to make.

      2. The interest rates would either rise or remain at the same level – with today’s less than expected inflation numbers RBI would be forced to cut rates. With EU, Japan, Denmark and other countries in the negative interest rate territory India can’t afford high interest rates.

      3. Someone looking at India as retirement country would have 10 to 15 more years of work outside of India and for them a longer lock in is a better bet. However people who don’t see themselves returning back to India are exposing themselves to FX risk because their future expenses would be in a foreign country and not in India. Even for those who want to go to India the cost of living after 5 – 10 years is impossible to predict.

      NRE FD’s might be a good investment for you based on your needs, cash flow and risk profile but looking at macro economic factors I am certain than a India is set for a rate cut of 50 basis points in 2016.

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  6. The NABARD Bonds were over subscribed 3.96 times on day 1 with retail subscription at .89 times. Which means anyone who subscribed on day 1 should get 100% allotment. IRFC bonds have opened today and given the size is smaller over subscription on day 1 is expected

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  7. This article explains tax free bonds well.

    wap.business-standard.com/article/pf/nabard-s-tax-free-bonds-offer-long-term-risk-free-investment-116030700684_1.html

    Basically if it is too good, then allocation will be low. It’s like ipo, good IPOs retail hardly get any allotment.

    Think about it this way, NRE deposits are only available to NRIs and we are at a competive advantage. Tax free bonds domestic investors can invest.

    So, if for NRIs itself NRE FDs are not good, then Indian domestic FD holders should just dump everything and buy tax free bonds.

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    1. The trick is to apply for the bonds on day 1 when the issue opens. Usually the allocation ratio is based on the oversubscription rate in the category for day 1 (if over subscribed).
      NRE FD’s are good but these Bonds are better. Bonds issued in 2013 are now quoted at 15 to 20% over face value with interest rate of 8.5%. I doubt anyone would have put money in NRE FD’s for 10 years or more which means that their reinvest rate would have gone down over the years. Anyone who puts money in NRE FD’s today can rest assured of getting a lower rate on reinvestment as and when the FD’s mature in 1 to 5 years.
      And YES smart investors would and are dumping FD’s in favor of these Bonds. It shows in the overwhelming demand and oversubscription of all issues.

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    1. Yes D. S., when I looked through and analyzed it seemed like a good option. Plus these are AAA rated bonds. Remember to share with your near and dear ones

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