For conservative investors and retirees, tax-free bonds are a good bet

Personal Finance

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Over the past year or so, many banks have slashed interest rates on the fixed deposits (FDs) they offer, due to the successive repo rate cuts by the Reserve Bank of India (RBI). For instance, State Bank of India (SBI) now offers just 4.9 per cent for 1 year to less than 2 years tenure, and 5.4 per cent for tenures of 5 years up to 10 years.

Also, over the past few years, credit quality issues in debt instruments such as rating downgrades and default in repayments have given trouble to many fixed income investors. Such credit events led to a sharp erosion in the value of the investment products that held these distressed assets in their portfolio. So, capital safety has now become a prime concern for many retail investors.

Given the low interest rate regime, investors looking for debt instruments that provide returns relatively higher than bank FD returns, and also capital safety can consider tax-free bonds available in the secondary market.

Conservative investors and also retirees in the highest tax bracket looking for a regular income on a yearly basis can consider buying these bonds from the secondary market.

 

A total of 193 series of tax-free bonds issued by 14 infrastructure finance companies from FY12 to FY16 are listed on the bourses. They are traded in the cash segment on the BSE and the NSE. These tax-free bonds were issued by public sector undertakings and public financial institutions that are backed by the government of India. Hence, the investments made in these tax-free bonds enjoy capital safety.

Further, the bonds issued by most of these companies have the highest credit rating of AAA. Instruments rated AAA are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry the lowest credit risk.

Attractive yields

Data compiled by HDFC Securities show that there are a handful of tax-free bonds with good credit rating that trade with relatively higher volumes and also offer reasonable yield to maturity (YTM) in the secondary market (see table). These include the series of PFC, NABARD, HUDCO and NHAI bonds.

 

For instance, the NHAI NR series (ISIN INE906B07EJ8), with a coupon rate of 7.6 per cent and residual maturity of 10.3 years, trade with a YTM of 4.8 per cent on the NSE. Since the interest paid by tax-free bonds are exempt from income-tax, the current yield of 4.8 per cent translates to 6.9 per cent pre-tax yield for investors in the 30 per cent bracket. This rate is higher than those offered by most bank FDs currently.

Both the BSE and the NSE facilitate the purchase and sale of tax-free bonds. These are listed and traded in the cash segment along with equity shares. Retail investors can buy and sell tax-free bonds through demat accounts.

While investing in tax-free bonds through the secondary market, investors should not just look at the coupon rate and the market price of the bonds. There are three parameters that they should consider — credit rating, YTM and liquidity.

YTM is the internal rate of return earned by an investor who buys the bond today at the market price, assuming that the bond is held until maturity, and that all coupon and principal payments are made on schedule.

HDFC Securities data shows that around 15 series of tax-free bonds were traded with YTM ranging from 4.4 per cent to 4.9 per cent and good daily average trade volumes over the last one month (see table).

Keep in mind that selling tax-free bonds in the secondary market attracts capital gains tax. If you sell them within 12 months from the date of purchase, you will have to pay tax on the gains as per your tax slab. If you sell after 12 months, tax has to be paid at flat rate of 10 per cent; no indexation benefit is available.

Factors to consider

Take into account the credit rating, YTM and liquidity of the tax-free bonds trading in the secondary market

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Reserve Bank of India – Speeches

Speeches

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Thank you for this opportunity to interact with eminent business leaders of India and distinguished members of the FICCI. I wish to thank the organisers for hosting this event, undeterred by this still unfolding pandemic that, on a daily basis, tests our resilience and capacity to save lives, households, businesses and the economy.

2. The end-August press release of the National Statistics Office (NSO) was a telling reflection of the ravages of COVID-19. Nevertheless, high frequency indicators of agricultural activity, the purchasing managing index (PMI) for manufacturing and private estimates for unemployment point to some stabilisation of economic activity in Q2, while contractions in several sectors are also easing. The recovery is, however, not yet fully entrenched and moreover, in some sectors, upticks in June and July appear to be levelling off. By all indications, the recovery is likely to be gradual as efforts towards reopening of the economy are confronted with rising infections.

3. The global economy is estimated to have suffered the sharpest contraction in living memory in April-June 2020 on a seasonally adjusted quarter-on-quarter basis. World merchandise trade is estimated to have registered a steep year-on-year decline of more than 18 per cent in Q2 of 2020, according to the Goods Trade Barometer of the World Trade Organisation (WTO). High frequency indicators point to a trough in global economic activity in April-June quarter and a subsequent recovery is underway in several economies, such as the USA, UK, Euro-area and Russia. The global manufacturing and services PMIs rose to 51.8 and 51.9, respectively, in August from 50.6 for both in July. Yet, infections remain stubbornly high in the Americas and are increasing again in many European and Asian countries, causing some of them to renew containment measures.

4. On the back of large policy stimulus and indications of the hesitant economic recovery, global financial markets have turned upbeat. Equity markets in both advanced and emerging market economies have bounced back, scaling new peaks after the ‘COVID crash’ in February-March. Bond yields have hardened in advanced economies on improvement in risk appetite, fuelling shift in investor’s preferences towards riskier assets. Portfolio flows to EMEs have resumed, and this has pushed up EME currencies, aided also by the US dollar’s weakness following the Fed’s recent communication on pursuing an average inflation target. Gold prices moderated after reaching an all-time high in the first week of August 2020 on prospects of economic recovery.

5. Financial market conditions in India have eased significantly across segments in response to the frontloaded cuts in the policy repo rate and large system-wide as well as targeted infusion of liquidity by the RBI. Despite substantial increase in the borrowing programme of the Government, persistently large surplus liquidity conditions have ensured non-disruptive mobilisation of resources at the lowest borrowing costs in a decade. In August 2020, the yield on 10-year G-sec benchmark surged by 35 basis points amidst concerns over inflation and further increase in supply of government papers. Following the RBI’s announcement of special open market operations (OMOs) and other measures to restore orderly functioning of the G-sec market, bond yields have softened and traded in a narrow range in September. Although bank credit growth remains muted, scheduled commercial banks’ investments in commercial paper, bonds, debentures and shares of corporate bodies in this year so far (up to August 28) increased by ₹5,615 crore as against a decline of ₹32,245 crore during the same period of last year. Moreover, the benign financing conditions and the substantial narrowing of spreads have spurred a record issuance of corporate bonds of close to ₹3.2 lakh crore during 2020-21 up to August.

6. The immediate policy response to COVID in India has been to prioritize stabilization of the economy and support a quick recovery. Polices for durable and sustainable high growth in the medium-run after the crisis, nevertheless, are equally important, and in my address today I propose to dwell upon that issue squarely – what could potentially lift up the Indian economy to trend growth as the recovery begins?

7. While interacting with members of the National Council of the Confederation of Indian Industry (CII) on July 27, 2020, I had covered five major dynamic shifts taking place in the economy: (i) fortunes shifting in favour of the farm sector; (ii) changing energy mix in favour of renewables; (iii) leveraging information and communication technology (ICT) and start-ups to power growth; (iv) shifts in supply/value chains, both domestic and global; and (v) infrastructure as the force multiplier of growth. Today, I would like to touch upon five areas that, I feel , would determine our ability to step up and sustain India’s growth in the medium-run: (i) human capital, in particular education and health; (ii) productivity; (iii) exports, which is linked to raising India’s role in the global value chain; (iv) tourism; and (v) food processing and associated productivity gains.

(i) Human Capital: The Importance of Education and Health

8. Investing in people adds to the stock of skills, expertise and knowledge available in a country, and that is critical to maximise its future growth potential. The assignment of importance to education dates back to Plato, Aristotle, Socrates and Kautilya. Its significance for economic development has received progressively increasing attention in recent decades, especially in the work of several Nobel laureates, including T.W. Schultz, Gary Becker, Robert Lucas and James Heckman. There has come about an explicit recognition of education as human capital in endogenous growth theory, backed up by cross-country empirical evidence.

9. In India, states with higher literacy rates are found to have higher per capita income, lesser infant mortality, better health conditions and also lower poverty. Education and skill development, however, contribute less than half a percentage point to our overall labour productivity growth. In order to reap the demographic dividend, we have to raise expenditure on education and acquisition of skills substantially. It is important to recognise that investment in education pays by raising average wages. In its Global Education Monitoring Report 2012, the UNESCO highlighted that every US$1 spent on education generates additional income of about US$10 to US$15. A World Bank (2014) study showed that an additional year of schooling increases earnings by 10 per cent a year. Higher education also contributes to economic development through greater sensitivity to environment/climate change, energy use, civic participation and healthy lifestyle.

10. The New Education Policy 2020 (NEP), a historic and much needed new age reform, has the potential to leverage India’s favourable demographics by prioritising human capital. The goal to increase public investment in the education sector to 6 per cent of GDP must be pursued vigorously. Public-private partnerships (PPPs) can develop necessary infrastructure, without jeopardising financial viability of private investment while ensuring quality education at affordable costs. Indian banks and the financial system would need to respond proactively to opportunities arising from the NEP for new financing.

11. Besides improving access to education, focus on quality of education and research will be critical to shape the outcome of education on economic development. Skill acquisition is more important than mere mean years of schooling. The assessment of quality aspect of education often requires a multi-dimensional approach: reading and language proficiency; mathematics and numeracy proficiency; and scientific knowledge and understanding1. The emphasis on quality of education must begin at the foundation stage in schools up to plus 2 level. At another level, the formation of the National Research Foundation as announced in the NEP is a welcome step to fund outstanding peer-reviewed research and to actively promote research in universities and colleges. The creation of a National Educational Technology Forum as a platform for use of technology in education is a necessary step to meet the requirement of rapidly changing labour market.

12. Health is another vital component of human capital. Good health increases life expectancy and productive working years. In high income countries, per capita health expenditure in 2017 was about US$ 2937, as against US$ 130 in low middle-income countries (which include India). Initiatives such as the Pradhan Mantri Bharatiya Jan Aushadi Pariyojana (PMBJP) and Pradhan Mantri National Dialysis Programme (PMNDP), free drugs and diagnostic service provision initiatives are expected to improve the quality and affordability of healthcare. The most important step towards providing affordable healthcare has been the launch of the Ayushman Bharat Yojna, which lays down the foundation of a 21st century health care system, covering both government and private sector hospitals.

13. COVID has brought to the fore the importance of easy access to health services to contain the mortality rate, given significant inter-state and intra-state differences in healthcare infrastructure. While laudable crisis time response to scale up health infrastructure has helped in dealing with the health emergency, a more comprehensive approach similar to NEP for the health sector may be warranted, which must also cover deeper penetration of insurance, given the high burden of out of pocket expenses in India, and also preventive care. Greater attention is required to improve the health ecosystem by ensuring creation of new medical colleges, higher number of PG seats and colleges for paramedics and nursing.

(ii) Productivity growth

14. By any reckoning, COVID-19 will leave long lasting scars on productivity levels of countries around the world. According to a recent World Bank assessment2, COVID-19 could entail adverse effects on productivity because of dislocation of labour, disruption of value chains and decline in innovations. During earlier episodes of epidemics in the past – Severe Acute Respiratory Syndrome (SARS), Middle East Respiratory Syndrome (MERS), Ebola and Zika – productivity is estimated to have declined by about 4 per cent over three years. The COVID impact on productivity could be expected to be much larger.

15. KLEMS (capital; labour; energy; materials; and services), a database hosted by the RBI, shows that the Indian economy experienced an overall productivity growth of 0.9 per cent per annum, on an average, over the period 1980-81 to 2017-18. In the immediate post-GFC period – from 2008-09 to 2012-13 – there was a decline in productivity by 0.3 per cent annually, while the period thereafter upto 2017-18 recorded annual productivity growth of 2.4 per cent. The contribution of productivity growth to the overall GDP growth of the Indian economy over the period 1980-81 to 2017-18 was about 15 per cent. During 2013-14 to 2017-18, its contribution increased significantly to about 34 per cent.

16. The share of patents applied and granted to India in total patents granted globally has been rising in recent years. India’s share, however, continues to be low at less than 1 per cent. Globally, the private sector plays a major role in R&D expenditure, while in India, a major part of R&D expenditure is incurred by the government, particularly on atomic energy, space research, earth sciences and biotechnology. Stepping up R&D investment in other areas would require more efforts by the private sector, with the government focusing on creating an enabling environment.

17. With a view to further promoting innovations in financial services, the Reserve Bank has announced an Innovation Hub with a focus on new capabilities in financial products and services that can help deepening financial inclusion and efficient banking services. Ongoing efforts are yielding results. India has recently entered the group of top 50 countries in the global innovation index (GII) list of 2020 for the first time. The India Innovation Index, released by Niti Aayog last year, has been widely accepted as a major step in the direction of decentralisation of innovation across all states of the country. Sustaining this process will be vital, given particularly the trend decline in saving and investment rate in India.

(iii) Exports and Global Value Chains (GVCs)

18. In the post global financial crisis (GFC) period, a view has emerged that the era of export-led growth is over, and India missed the opportunity by not prioritizing exports at the right time. Globally, the key impediments to exports post-GFC include: (a) generalized increase in protectionism by trading partners; (b) weak global demand conditions; (c) race to the bottom (to gain unfair competitive advantage, by using a policy mix of competitive depreciation, subsidies, tax and regulatory concessions); and (d) automation, reducing the cost advantages stemming from cheap labour.

19. Notwithstanding these impediments, and also the significant decline in trade intensity of world GDP growth in the post-GFC period, opportunities for expanding exports arise from the vastly altered global landscape for trade where more than two thirds of world trade occurs through global value chains (GVCs)3. The higher the GVC participation of a country, the greater are the gains from trade as it allows participating countries to benefit from the comparative advantage of others participating in the GVC. Services such as transportation, banking, insurance, IT and legal services, branding, marketing and after sale services are integral to GVCs.

20. India’s participation in GVCs has been lower than many emerging and developing economies. India has global presence in low GVC products such as gems and jewellery, rice, meat and shrimps, apparels, cotton, and drugs and pharmaceuticals.

21. Among the sunrise sectors that offer potential for higher exports in the post-COVID period are drugs and pharmaceuticals where India enjoys certain competitive advantages. With strong drug manufacturing expertise at low cost, India is one of the largest suppliers of generic drugs and vaccines. Some Indian manufacturers have already entered into new partnerships with global pharma companies to produce vaccines on a large scale for both domestic and global distribution. The Government has also approved an investment package for promotion of bulk drug parks and a production-linked incentive scheme is in place to enhance domestic production of drug intermediates and active pharmaceutical ingredients. A sharp policy focus on other GVC intensive “network products”, including equipment for IT hardware, electrical appliances, electronics and telecommunications, and automobiles would also provide the cutting edge to India’s export strategy with considerable scope for higher value additions.

22. Domestic policies need to focus on the right mix of local and foreign content in exports while aiming to enhance participation in GVCs. Firms that engage in both imports and exports are found to be far more productive than non-trading firms (World Bank, 2020)4. While choosing trade partners through free trade agreements (FTAs), it is also important to learn from global experience and nurture those trade agreements that go beyond traditional market access issues. Provisions relating to investment, competition, and intellectual property rights protection have a larger positive impact on GVC trade and need to be assiduously cultivated and ingrained into India’s export ecosystem.

(iv) Tourism as an Engine of Growth

23. Tourism has been one of the sectors in the economy most severely impacted by COVID-19. At the same time, this is also a sector where pent up demand could drive a V shaped recovery when the situation normalises.

24. India has immense potential to meet a diverse range of tourist interests – religion; adventure; medical treatment; wellness and yoga; sports; film making; and eco-tourism. We have four major biodiversity hotspots, 38 UNESCO World heritage sites5, 18 biosphere reserves, over 7,000 km of coastline, rain forests, deserts, tribal habitation and a multi-cultural population. The challenge nevertheless is to scale up our tourism market and enhance its contribution to economic development.

25. As per the Third Report of Tourism Satellite Account for India (TSAI) 2018, the share of tourism in GDP was 5.1 per cent in 2016-17 and the share in employment was 12.2 per cent (with the direct and indirect shares at 5.32 per cent and 6.88 per cent, respectively). In 2018-19, tourism’s share in employment increased further to 12.8 per cent, with the total size of employment at 87.5 million. The employment elasticity in this sector, thus, appears to be high. India attracted 10.89 million foreign tourists in 2019, an increase of 3.2 per cent over the previous year. The foreign exchange earnings generated by the sector during the same period was about ₹2 trillion, a year-on-year increase of more than 8 per cent. The country also jumped six positions to 34 out of 140 counties in the Travel and Tourism Competitiveness Index 2019 of the World Economic Forum (WEF).

26. Recognising the potential of the sector, the Government has provided targeted policy support. The Ministry of Tourism has two major schemes: Swadesh Darshan for Integrated Development of Theme-Based Tourist Circuits; and PRASHAD as a Pilgrimage Rejuvenation and Spiritual, Heritage Augmentation Drive for development of tourism infrastructure in the country, including historical places and heritage cities.

27. The multi-pronged supportive policy interventions in the sector may have to be reviewed and revamped, if tourism has to contribute more to the economy matching its potential. A closer look at some of the global leaders in travel and tourism such as France and Spain would suggest that these countries not only have excellent natural and cultural resources, but policies to support an exceptionally attractive tourist infrastructure, including a high hotel density offering all range of choices, quality public transport systems, networked air connectivity with considerable route capacity, and most importantly, safety and security.

28. Initiatives need to be taken in the direction of improving and integrating various modes of transportation (linking air/train/metro/road/sea) with the provision for single point of booking, e-registration of service providers (travel agents, transport operators, hotels, tourist guides, etc.). Strict provisions of penalty for non-compliance would boost confidence of tourists, alongside an effective and speedy grievance redressal system for both domestic and foreign tourists. Research conducted by a private agency6 suggested that if we can increase international tourist arrivals to 20 million (i.e., about double of current arrivals), the incremental income would be US$19.9 billion, benefiting an additional 1 million people in the travel and tourism industry.7

(v) Food Processing for Surplus Management

29. COVID has brought the importance of food security and food distribution or supply chain network to the forefront of public policy debate in India. Successive years of record production of foodgrains and horticulture crops has transformed India into a food surplus economy. Recognising this challenge, much of the policy attention in recent years for the sector has focused on addressing post-production frictions, comprising agri-logistics, storage facilities, processing and marketing. Greater focus on processed food is one option that could help in dealing with multi-pronged challenges of surplus management. Development of the food processing industry is likely to benefit the farm sector and the economy through greater value addition to farm output, reducing food wastages, stabilising food prices, expanding export opportunities, encouraging crop diversification, providing direct and indirect employment opportunities, increasing farmers’ income and enhancing consumer choices.

30. Food processing is a sunrise industry. Globally, its importance in the consumer basket has increased over time, led by rising per capita incomes, urbanisation, and change in consumer perceptions regarding quality and safety. Despite having huge growth potential, the food processing industry in India is currently at a nascent stage, accounting for less than 10 per cent of total food produced in the country. As a result, despite being one of the largest producers of several agricultural commodities in the world, India ranks fairly low in the global food processing value chain.

31. There is a need to move up the value chain. Moreover, the food processing industry in India is largely domestically oriented, with exports accounting for only 12 per cent of total output. India can move up in the global agricultural value chain by increasing its share of processed food exports, for which quality standards will be a critical factor.

32. Food processing also offers huge employment potential. In India, while the food processing industry’s contribution to overall Gross Value Added (GVA) is only 1.6 per cent, it accounts for 1.8 million (12.4 per cent) and 5.1 million (14.2 per cent) jobs in registered and un-incorporated sectors, respectively. Recognising this, the government has set the target for raising the share of processed food to 25 per cent of the total agricultural produce by 2025. The food processing sector was also opened up for 100 per cent FDI in 2016 under the automatic route. Further, in 2017, 100 per cent FDI under the government route for retail trading, including through e-commerce, was permitted in respect of food products manufactured and/or produced in India. For ensuring adequate credit flows, the Reserve Bank has accorded priority sector status to the food processing industry in 2015.

Conclusion

33. In my address today, I have highlighted five critical areas that can determine the shape of our post-COVID trend growth. While dealing with the immediate crisis management challenges, we need to strategically prepare for our combined overriding goal – the pursuit of strong and sustainable growth. The private business sector has a critical role in each of the five areas I covered today. The enabling policy environment would evolve around the initiatives taken by India’s businesses to seize these opportunities and actualise the potential of the Indian economy as a rising economic power of the 21st century. COVID-19 has changed our lives and it is increasingly clear that life will never be the same again. We should look upon these fundamental changes as opportunities rather than threats, converting them into game changing new vistas of progress. I do believe that together as a nation, we can certainly do it. Let me conclude on this optimistic note.

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Loan guarantor? Know these risk factors

Personal Finance

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Standing guarantee for a loan is providing a helping hand to someone who is unable to get a loan on their own.

However, it comes with increased liability and financial risk for the guarantor.

Here are some crucial factors that a person should consider before agreeing to be a loan guarantor.

Why a guarantor

Co-borrower(s) of a loan shares the responsibility of making regular repayments with the primary borrower.

Co-borrowers can be usually selected from the list of close relations specified by the lender.

A loan guarantor comes to the scene only when the primary borrower and co-borrower(s), if any, fail to repay the loan.

The guarantor can be anyone beyond the specific relations listed by the lender.

Lenders can ask a prospective borrower to loop in a guarantor when they are unsure or not satisfied with the primary and co-borrower’s eligibility and repayment capacity.

High loan amount, poor credit scores of loan applicants, primary borrower nearing or beyond the cut-off age for applicants, risky job profile or employer profile of the applicants, etc, are some factors that prompt lenders to ask for someone to stand guarantee for loan.

Lenders can ask for guarantors in any type of unsecured and secured loans.

As in the case of primary borrower and co-applicants, the lenders will consider the credit score, income, job profile, repayment capacity, employer profile, etc, of the proposed guarantor while evaluating their eligibility.

Liabilities of guarantor

A loan guarantor is liable for the timely repayment of the guaranteed loan in case the primary borrower and co-borrower(s), if any, fail to do so.

Whenever the default happens, the lender can demand the loan guarantor to step in and repay the outstanding loan amount along with the penal rates and charges incurred due to the non-payment of loan dues.

Hence, those being roped in as guarantors should persuade the primary applicant and co-applicant, if any, to opt for a loan protection insurance plan. This will reduce the liability of the loan guarantors arising from loan default due to unfortunate demise or disability of the primary/co-borrowers.

Remember that these insurance plans do not cover loan default, they only cover the contingency arising out of demise or disability of the primary/co-borrower of the loan.

Credit score, loan eligibility

Any default or delay in the loan repayment by the primary borrower and co-borrower(s) will adversely impact the credit score of the loan guarantor as well. Hence, before accepting the role of a guarantor, one should always make sure that the primary and co-borrowers are financially stable and disciplined to make timely repayments.

Existing guarantors should keep a close tab on the repayment activities in the loans they guaranteed. Alternatively, guarantors can also fetch their credit reports at regular intervals as any delay or default in repayments will reflect in their credit reports as well.

Once a person stands guarantee for a loan, the loan amount they are eligible for gets reduced by the outstanding amount in the guaranteed loan. Lenders consider the outstanding loan amount in the guaranteed loan as contingent liability of the guarantors. Hence, one should always assess one’s probable financing requirements in the short and mid term before committing to standing guarantee for a loan.

The loan guarantor cannot withdraw from their responsibility till the lender and primary and co-borrower(s) find a mutually acceptable new replacement for the original loan guarantor. This is another reason why a loan guarantor should carefully assess their near- and mid-term financing requirements before agreeing to be a guarantor.

The writer is Director, Unsecured Loans, Paisabazaar.com

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Readers Say – The Hindu BusinessLine

Personal Finance

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This is in the context of a story titled ‘Why you shouldn’t delay repaying loans anymore’ that appeared in BusinessLine on September 6. It says: “Can you pay the entire EMIs pertaining to the moratorium period at one go to lessen the pain? If you have ample funds, that would seem a prudent move but it is likely that your bank may not allow such repayments. According to HDFC Bank website, the unpaid EMIs cannot be paid in lump sum.” What could be the economic reasoning for such a restriction by the bank?

Anil K Sood

Our response: Even in the case of normal loans, one cannot make lump-sum partial payments. At best, loan can be foreclosed after paying certain charges. This is essential for ALM ,or asset-liability management, by banks — loans and deposits coming up for payment at a specific time. Too much uncertainty in loan repayments can be hard to manage.

This is in the context of the story titled ‘What makes Petronet LNG a good bet over the long term’ that appeared in BusinessLine on August 23. It is indeed an insightful analysis . The key to boost revenues and profitability is the Kochi-Manglore pipeline and the associated network. It has taken ages for its completion due to various factors.

Vishal Kelkar

I thank you for responding to my query ‘What is indexation? How is it calculated? What is its relevance for tax treatment of STCG/LTCG in mutual funds?’ that appeared in BusinessLine on August 30. For better understanding for investors, students and academicians, certain concepts, including financial modelling, rental discounting, short-term money market instruments, index funds and G-Sec yields, may be explained in the coming days, highlighting their application, present trends and the precautions to be adopted by investors.

AS Venkata Rao

The BusinessLine Star Track MF Rating of MF is really good. It is unique as the star rating comprises rolling returns, downside risk and also one-year performance. It would be more helpful if the data was downloadable in excel format. Request you to rate overnight funds and liquid funds as well.

Raghavendra

Readers can share their views in the comments section on our website (thehindubusinessline.com/portfolio/). You can also send your feedback and suggestions to blportfolio@thehindu.co.in, or tweet at us @Blportfolio

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Why you shouldn’t delay repaying loans anymore

Personal Finance

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For many of us, the outbreak of Covid-19 pandemic has been quite a drain on our finances.The six-month moratorium on loan repayments provided by banks eased the pain of those who opted for the relief.

The moratorium on loan EMIs expired on August 31. The Supreme Court is currently hearing a matter regarding waiver of interest on loan moratorium. Hence more clarity on the moratorium and interest that banks have been charging on your loan under moratorium is awaited. However, it is advisable that you prepare yourself to resume your loan repayments and know your options. If you have given an auto debit mandate, then your bank will start debiting your EMIs from your account on the same day of the month as agreed upon earlier.

Will your EMIs remain the same as it was before opting for the moratorium? Can you pay a lump sum amount to clear your dues post moratorium period? Will the bank grant any additional relief if you are still unable to meet loan commitments ?

Here, we attempt to answer these queries based on our interactions with banks and FAQs put out on certain websites. These may of course change, post the SC’s final order.

No change in EMI amount

If you availed of the moratorium relief, you must remember that your bank would have continued to charge you interest on the outstanding loan amount at the rate applicable for the respective loan during the moratorium period (this is currently under review by the SC). This interest has been added to your principal amount–essentially the unpaid EMIs along with the accrued interest have been added to your loan outstanding.

This will result in the increase in the tenure (residual) of your loan and not your EMIs. Hence your EMI would remain the same but the tenure of your loan would have increased. For instance, if you had taken a home loan from SBI of ₹30 lakh with a remaining tenure of 15 years, the additional interest payable would be about ₹4.54 lakhin case you availed moratorium for six months. This would lead to increase in tenure of your loan by 16 months (additional 16 EMIs). The revised repayment schedule will be mailed to your registered email ID. You can also login to NetBanking and download the repayment schedule.

As has been communicated by various banks before and advised earlier (https://www.thehindubusinessline.com/portfolio/personal-finance/go-for-emi-moratorium-only-if-you-are-cash-crunched/article31235150.ece), deferment of big-ticket loan payments can pinch you quite a bit, given the substantial increase in the overall interest and loan tenure. But if you have still opted for the moratorium, owing to your financial situation, start making payments right away.

Can you pay the entire EMIs pertaining to the moratorium period at one go to lessen the pain? If you have ample funds, that would seem a prudent move but it is likely that your bank may not allow such repayments. According to HDFC Bank website, the unpaid EMIs cannot be paid in lump sum. But you can contact your bank to see if any option is available for you to settle payments in lump sum. Also, you can foreclose your loan if you have sufficient funds. Do check for foreclosure charges though.

Track your credit score

If you opted for the moratorium, remember that it would not have qualified as a default and hence your credit score should not have been affected. But it is advisable that you run a check on your credit score to ensure that there has not been any adverse impact on it because of opting for the the moratorium. Credit scores are given by credit bureaus such as CIBIL and Experian. You can approach them if you notice any change in your credit score during the moratorium period.

But note that any delay in payment of dues after the expiry of the moratorium could qualify as default and impact your credit score. Hence, if you have the necessary funds, clear your dues on time now onwards to avoid a negative impact on your credit score which can affect your loan-taking ability in future (may also lead to higher loan rates in future).

Restructuring is an option

All of the above mentioned points apply only if you are comfortable paying your EMIs. What if you are still cash-crunched and are unable to resume EMI payments ?

In a bid to provide some relief to borrowers amid the pandemic-induced crisis, the Reserve Bank of India (RBI) had allowed banks to restructure loans across the board — auto, credit card, housing, personal loans, education and loans given for investment in financial assets such as shares, debentures etc.

Restructuring normally involves rescheduling of EMIs (maybe lower outgo), grant of additional moratorium or extension of loan tenure to allow borrowers some breathing space. However, individual banks may or may not grant such relief based on their assessment of the borrower’s income stream, past record or other parameters. Hence, check with your bank on what they can offer you.

In any case, the maximum period by which the loan can be extended (if restructured) is two years, according to the RBI regulations. Also, you are eligible for a loan restructuring only if your account was ‘standard’— not in default for more than 30 days as on March 1, 2020.

Above all if you are able to source additional funds and repay your EMIs that would always be a better option than going in for restructuring, which can increase your burden over a period of time and may impact your credit score too.

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What should home buyers know about stamp duty and registration charges?

Personal Finance

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Since the outbreak of the Covid-19 pandemic, demand for house property has slowed, with many postponing big-ticket purchases. In a bid to attract home buyers, the Maharashtra Government recently announced reduction in stamp duty rates on property purchases. It has lowered the stamp duty rate to 2 per cent (from 5 per cent) of the property value; this is applicable across Maharashtra from September 1 to December 31, 2020. The State has kept the stamp duty rate at 3 per cent from January 2021 to March 31. This reduction in stamp duty rates is expected to boost residential demand, and help developers bring down the level of unsold inventories in the market.

With demand slowdown in the property market and economic uncertainty, property prices too have remained stagnant, and in some regions it has declined. As stamp duty rates (and registration charges) add to the total cost of the property, any increase or decrease in these rates influences demand to some extent. So, if you are looking to buy a property, it would be good to have a fair idea about these charges.

Basics

In addition to the property price, a home buyer has to incur other charges as well, most of which are mandatory. Among such unavoidable expenses are stamp duty and registration charges that are payable to the respective state Governments.

Stamp duty is the tax levied when a property is transferred from the seller to the buyer.

The receipt or acknowledgement of payment of stamp duty is a crucial, legally recognised document that acts as proof of ownership in court, in case of any dispute. So you are considered an owner of a house property when your sale agreement is registered and signed, and the stamp duty and registration charges are paid. Stamp duty is applicable on conveyance deeds, sale deeds and power of attorney papers and this rate varies with each State (2-8 per cent). For instance, stamp duty in Maharashtra is currently around 2 per cent of the value of the property, while in Tamil Nadu, it is around 7 per cent.

Registration fee, on the other hand, is charged to record the execution of transaction between the buyer and the seller. This, too, varies with each State. For instance, in Maharashtra, registration charges are around ₹30,000 (flat fee), while in Karnataka, it is 1 per cent of the value of the property.

The amount paid as stamp duty and registration charges depends on the value of the property and the circle rate (price of the residential or commercial property or land for a given area, published and regulated by the state government), whichever is higher.

Aarthi Lakshminarayanan, Partner, Shardul Amarchand Mangaldas & Co, says “The value of any house or building, in Tamil Nadu, is arrived at based on a common schedule of plinth area rates prepared by the PWD department and published by the Government of Tamil Nadu every year”.

Do keep in mind that, both stamp duty and registration charges, are over and above the purchase value of the property. So, if you are a buyer, plan for such outgo as well at the time of buying a property.

Say, the house property you plan to buy is a resale property and costs ₹1 crore. While this is the price you pay to the seller, you will have to pay stamp duty of, say, 7 per cent and registration of, say, 4 per cent, (on ₹1 crore), in addition to the purchase price. In total, you will pay ₹1.11 crore (₹1 crore plus 11 per cent on ₹1 crore).

In case of under-construction property, the payment varies with each state. In Tamil Nadu, for instance, you will pay stamp duty on the guideline value or market value of undivided share (land), whichever is higher. Say, the cost of property is ₹60 lakh, of which the undivided share of land accounts for ₹20 lakh, then the stamp duty (7 per cent) and registration charges (4 per cent) are levied on this amount. On the balance ₹40 lakh, registration charges of 1 per cent (in Tamil Nadu) on the cost of construction or the amount mentioned in the construction agreement, whichever is higher, will apply. The Government of Tamil Nadu also charges 1 per cent stamp duty on the same. You will also have to pay Goods and Services Tax (GST) (around 5 per cent or 1 per cent in case of affordable housing) on the total consideration of the property. GST is not applicable on completed properties.

Payment

Usually, it is the buyer who pays the stamp duty at the time of registration of property. There are two popular ways to make this payment: e-stamping and through non-judicial stamp paper.

When it comes to e-stamping, a buyer has to visit the website of Stock Holding Corporation of India, the central record keeping agency for all e-stamps in the country. It has authorised collection centres (ACC) that issue such e-stamps. You can go to schilestamp.com and check if your State government provides for such facility.

So, if your State allows e-stamping, first you will have to fill an application by providing details of the transaction, name of the parties involved (buyer and seller) and PAN number of the parties, value of the property (for which stamp paper is required), and mode of payment (NEFT/cheque/DD). If you are making payment via NEFT, then the website will generate an acknowledgement for the payment. Next, at the ACC, buyers/payers have to submit the filled up form along with the amount to be paid as stamp duty or submit acknowledgement. The e-stamp certificate will be generated immediately after realisation of the funds.

The advantages of using e-stamps are that it can be generated within minutes and is tamper proof. But on the downside, once an e-stamp is generated, it is a difficult process to modify or cancel the e-stamp; so, fill the details with care.

With restrictions of movement due to the coronavirus, home buyers can pay stamp duty online and print e-stamp certificate from home. But this facility is provided only by a few states such as New Delhi, Karnataka and Chandigarh. You can also use the e-payment facility, if provided, by your State government for making payment of both stamp duty and registration charges.

Another and the most common method of paying stamp duty is by purchasing non-judicial stamp paper from a licensed vendor. Under this, the stamp paper — either purchased for the value of the stamp duty or a lesser amount (rest can be remitted as cheque or DD to the designated banks), will contain the agreement details and should be signed by the parties involved.

Note that once the payment of stamp duty is made and signed by the parties, registration of the property can be done immediately or within a certain time period, say three to six months. The applicable registration charges will be paid at the time of registration of property.

Payment modes:

e-stamping

e-payment

Non-judicial stamp paper

Additional cost to buyer

Stamp duty and registration charges are costs over and above the cost of a house property

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What’s better – Investing in equity mutual funds or investing directly in stocks?

Personal Finance

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Amit has been investing in mutual funds for the last seven years. He is not happy with the returns, as they have been much below his expectations. He invested in a few small-cap stocks in March 2020. Some of those stocks have given more than 100 per cent returns in the last three-four months.

However, Amit did not really invest big amounts in those stocks. Hence, those investments have not made a meaningful difference to his portfolio.

Now, he wants to revisit his entire equity strategy. There is a sense of disillusionment with mutual funds and he is unsure if the mutual funds are worth investing in.

He wonders whether investing directly in stocks is a better approach than investing in mutual funds.

Flavour of the season approach

Amit has not focussed on allocation within various equity categories and has gone with the flavour of the season approach. He invested a lot of money in small-cap funds in 2017 when small-cap stocks were doing well. But the small-cap stocks have been under pressure since the beginning of 2018. While the broader equity markets have done not too well over the last couple of years, Amit’s portfolio has struggled even more due to higher allocation to small-cap funds.

Whether he invests directly in stocks or through mutual funds, the underlying exposure is to a volatile asset. Both the approaches have merits and demerits. If he gets his direct equity picks right, he can earn above-normal returns. However, if his bets go wrong, there can be serious wealth destruction. Mutual fund schemes have diversified equity portfolios and help hedge bets. While this reduces return potential, this also reduces risk.

Amit’s stock picks did very well over the past few months, and he deserves credit for his choices. However, he must not mistake luck for skill. Stock research requires time and skill. Four or five months of investing or getting two or three stock calls right does not establish skill. If he is very keen on investing a significant portion of equity portfolio in direct stocks, he must test his stock-picking skill and market judgement for a few years. Only then, should he allocate greater capital to direct stocks.

By the way, over the past four-five months, even some small-cap funds have returned more than 50 per cent. A rising tide lifts all the boats. Amit must remember that something similar happened in 2017 and he has experienced the subsequent pain. While no one can say with certainty whether the performance of the past few months will sustain or there will be a reversal, he must remain cautious.

At the same time, this does not imply that direct equity investing must be shunned completely. There is a middle ground. If Amit wants to take exposure to direct stocks, he must first set up a threshold for the direct equity exposure. For instance, he can limit direct equity exposure to say 20 per cent of the equity portfolio. Therefore, if his equity portfolio is ₹10 lakh, not more than ₹2 lakh should be in direct equity. This way, he can strike a balance between the two modes of equity investments.

Amit can set aside money for stocks that he has researched well and thinks offer potential for good returns. Mutual fund investments, if selected well, will diversify equity exposure. Therefore, this internal limit helps him retain upside potential of his stock picks. In addition, this helps him maintain discipline and not get carried away and take unnecessary risks.

If he is satisfied with the results of direct equity investments, he can increase the threshold after a few years.

Within the mutual fund portfolio, Amit can split investments across two-three funds. He can invest in a large-cap and a mid-cap fund. Or he can pick up a multi-cap fund. Remember four small-cap funds do not build a diversified equity portfolio. If he does not trust active fund management, he can simply invest in index funds or exchange-traded funds (ETFs). There are now passive options across the market spectrum.

The word “diversify” has been used loosely when referring to equity mutual funds. Note that true diversification does not happen when you add different types of equity products to the portfolio. You diversify the portfolio by adding assets with low correlation. For instance, adding a fixed income product to an equity portfolio diversifies the portfolio.

Asset allocation is of vital importance. Sub-allocation within the equity portfolio is secondary.

(The writer is a SEBI-registered investment advisor at personalfinanceplan.in)

True diversification

Having assets with low correlation helps in true portfolio diversification

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Will employees gain if gratuity rules are tweaked?

Personal Finance

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The Centre is said to be mulling a key change in the rules pertaining to gratuity payment by employers.

So, for an employee to be eligible for gratuity benefit, the minimum period of service could be reduced from the current five years to one-three years, say reports.

This is in keeping with the changing dynamics of the job market where many employers and employees prefer shorter-term engagements, rather than the practice of decades-long service.

If the threshold for getting gratuity benefit is reduced, it could act as a boost for many, including short-tenure and contract workers — especially in the present times when many employees are being laid off due to the coronavirus impact.

A lower period of service will be another major relaxation after the doubling in the maximum limit on gratuity payment, from ₹10 lakh to ₹20 lakh, a few years ago. As it stands, here’s how the gratuity benefit works and the tax benefits associated with it.

Reward for loyalty

Gratuity is like a retention bonus — a reward for employee loyalty given by the employer. Just that this reward is mandated by law and not at the discretion of the employer.

So, if you stay on with your employer for five years or more, you are entitled to receive gratuity when you retire, resign or are retrenched. Note that the service has to be continuous in nature, that is, at one stretch.

So, if you work with an employer for three years, resign, but later rejoin and work another thee years before leaving again, you will not be entitled to gratuity despite a service record of more than five years. That’s because the period of service was broken and not continuous.

The monetary reward to be paid by an employer in recognition of an employee’s years of service is laid down by the Payment of Gratuity Act, 1972. Most establishments employing 10 or more workers come under the Act. Once an organisation comes under the Act, it will remain so, even if the number of employees falls below 10.

Roughly said, you get half a month’s Basic and Dearness Allowance (DA) for every completed year of service as gratuity. Here’s how it is calculated: (Number of years of service) x (Last drawn monthly Basic and DA) x 15/26.

So, if you have served 25 years and draw a monthly Basic and DA of ₹30,000 when you leave the job, you get gratuity of ₹4,32,692, calculated as 25 x 30,000 x 15/26. If you serve more than six months in the last year of employment, it is considered as a full year of service.

For instance, service of 24 years, eight months will be considered as 25 years.

Your employer can choose to pay you more, but the maximum amount of gratuity according to the Act cannot exceed ₹20 lakh. Amounts paid above this will be in the nature of ex gratia.

There are exceptions and legal rulings that relax the five-year continuous service rule. One, the rule is waived if an employee dies or is disabled.

Next, the Madras High Court in the Mettur Beardsell case had ruled that if an employee completes four years and 240 days in service, he will be eligible for gratuity.

Tax break

You get a favourable tax treatment under Section 10(10) of the Income Tax Act on the gratuity amount you receive.

If you are a government employee, the entire amount you get is exempt from tax. If you are not a government employee, but are covered under the Act, the tax exempt amount is the lower of the following: a) Actual gratuity received; b) 15 days Basic and DA for each completed year of service or part thereof in excess of six months (as per calculations in the above example); c) ₹20 lakh.

Say, in the example above, your employer paid you gratuity of ₹5,00,000, which is more than the ₹4,32,692 actually payable under the law. You will enjoy tax exemption on ₹4,32,692 and the balance ₹67,308 will be subject to tax.

Consider another example in which the gratuity payable to you as per the formula comes to ₹25 lakh and the employer pays you the amount.

But the current cap on gratuity payable and tax exemption is ₹20 lakh. So, ₹20 lakh will be tax exempt and the balance ₹5 lakh will be taxed. Note that the total tax exemption on gratuity amount received, including those from previous employers in earlier years, cannot exceed ₹20 lakh.

Employees not covered under the Payment of Gratuity Act also get tax benefit if their employers give them gratuity.

But in such cases, the tax exempt amount is the lower of the following: a) Actual gratuity received b) 15 days Basic and DA for each completed year of service calculated as (number of years of service) x (average monthly salary in the last 10 months of employment) x (15/30). c) ₹ 20 lakh.

Note that in such cases, the number of years of service will be only the full years in service; part-year service will not be considered even if it exceeds six months in a year.

For instance, service of 24 years, eight months will be considered as 24 years.

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Readers say – The Hindu BusinessLine

Personal Finance

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This is in the context of the Big Story titled ‘Unlock your investment plans from home’ dated August 15, 2020. Would like to say that the article had an excellent coverage.

Girraj Sharan

This is in the context of the Big Story titled ‘What lies ahead for the rupee?’ that appeared in BusinessLine on August 10. I am willing to bet against the rupee. The fundamentals of the Indian economy are weak. In the equity market, it is one stock that has pulled the index up; domestic institutions, led by government desire, have driven the rally. Barring the monsoon, I don’t see any positive. Most States still have lockdowns in force in some form or other. Dollar weakness is partly due to approaching US polls. It is difficult to share your optimism.

Ramanujam P B

I read the article titled ‘Gold ETFs eye futures for that extra edge’ dated August 3, 2020. It deserves praise for adding a cautionary takeaway. The article could have added more value if it had mentioned the face value and the present NAV in the table carried in the story.

N Mukunda Kumar

Readers can share their views and suggestions in the comments section on our website (thehindubusinessline.com/portfolio/), mail them to blportfolio@thehindu.co.in or tweet at us @Blportfolio

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