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Suresh Krishnamurthy

As of now, debt offers after-tax annual returns of 6-6.5 per cent for an investor in the 20 per cent tax bracket. This could change and the after-tax return could edge above 7 per cent. This would make investing in debt — either through mutual As of now, debt offers after-tax annual returns of 6-6.5 per cent for an investor in the 20 per cent tax bracket. This could change and the after-tax return could edge above 7 per cent. This would make investing in debt — either through mutual

THE staid old world of fixed-income investing received a jolt in the Budget announced at the end of last month with the removal of Section 80-L.

This Section ensured that interest income did not suffer tax up to Rs 12,000 per annum. That has brought on par all fixed-income instruments, excepting debt-oriented mutual funds from the perspective of taxation of interest income.

The only differentiating factor between various savings instruments now is the risk involved. This change itself could revive fixed-deposit investing in manufacturing and non-banking finance companies.

More changes could follow in the next few years — that of bringing on par all fixed-income investments with respect to tax deduction at source; specifically, the introduction of TDS for post-office savings schemes. Along with reduced liquidity in the system — courtesy continued economic growth — removal of TDS could make investing in debentures and fixed deposits of the corporate sector more competitive. Investing in these instruments directly or through mutual funds is thus set to become more attractive.

Debt investing unattractive: As things stood before the Budget, small savings schemes were by far super-efficient in terms of tax payable on interest income.

The income was deductible under Section 80-L; interest from small savings, therefore, did not lead to tax outgo for a large number of investors.

Importantly, there was also no tax deduction at source. As such, even if tax was payable, there was considerable scope for tax evasion.

Small savings also offered extremely attractive interest rates. Therefore, for long-term investing, there was simply nothing to beat these schemes.

The abundant liquidity also ensured that manufacturing companies and non-banking finance companies could access funds at extremely fine rates — rates that made no sense for the retail investor to consider investing.

This checked growth in the fixed-deposit market. Except for Hudco and Sardar Sarovar Nigam, almost all large deposit-taking companies have reported a decline in their fixed deposit base over the past few years.

For the short term, investors still prefer term deposits in banks. The interest rate on bank term deposits is the lowest on offer. It is, however, convenient to invest in and redeem.

No wonder, despite the significant decline in interest rates and the large base, at above Rs 16-lakh crore, inflows into bank term deposits keep rising at double-digit rates every year.

The tax deduction requirements for bank term deposits are also relatively lax. Besides, the after-tax returns on mutual funds were themselves not competitive.

Not surprisingly, debt-oriented mutual funds virtually hemorrhaged in 2004-05. Debt investing in recent times was quite simple; for long-term — small savings; short-term — term deposits in banks.

Set for change: This simple investing rule may soon change. Lending rates of banks could now approach 8 per cent or higher, even for top-rated corporates.

The tax efficiency of all deposits and debentures is now on par. If top-rated companies access either the public or private capital market, they will be able to access funds at 7-8 per cent.

The corporate sector is also under-leveraged. There is thus a strong case for several of the corporate giants to come up with debt offers.

A number of companies are already doing it now, although they are accessing the overseas market and raising funds in foreign currency. If they start pursuing the domestic investor, the stage would be set for a healthy dose of disintermediation.

Usually, banks intermediate between the borrower (companies) and the lender (retail depositor). When borrowers directly take funds from the lender, it would be a case of disintermediation, and chances are bright for that to happen.

Another interesting development is the benefit given in the Budget for securitised debt. Securitised debt, which is a portfolio of loans sold by a lender to investors, will offer a higher yield than other competing options.

As of now, debt offers after-tax returns of 6-6.5 per cent for an investor in the 20 per cent tax bracket. This could change and the after-tax return could edge above 7 per cent.

This would make investing in debt — either through mutual funds or directly — much more attractive. That would also lead to more depth in the debt market.

Correction: In the `Taking Count' published last week it was stated that a minimum of Rs 100 is needed to be invested in PPF every year. A reader, A. Davidson, of Bangalore has pointed out correctly that with effect from November 2002, the minimum annual investment in PPF is Rs 500. The error is regretted.

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