There has been consternation about Foreign Currency Convertible Bonds, or FCCBs recently, and this is a more detailed post on them.
What are FCCBs
An FCCB is basically like this:
- You give me dollars
Debt
Government Debt: A Visual Analysis
Our government is going to issue a truckload of bonds next year, so let’s see where we are right now with respect to current bonds outstanding.
Total Bonds Issued: 18,26,501 cr. (18.26 trillion, excludes MSS of 2000 cr.)
Total Interest we will pay next year: 146,610 cr.
Total Taxes Collected (Estimate): 746,651 cr.
Interest paid as a % of taxes: 19.64%.
This is quite high – and the taxes mentioned are gross amounts – net of state sharing, and including certain non tax revenue items like dividend and interest received, the real revenue of the government is just 682,212 cr. – interest being paid out is 21.5% of that!
Let’s then look at how much is maturing in which year:
Source: Finmin
Around 106K cr. matures this year, and will have to be paid out. According to the budget speech, we expect an ADDITIONAL net borrowing of 345,010 cr. this year, for the deficit of about 381,000 cr. Add that to the 106,000 cr. maturing, and we end up with a financing requirement of 451,000 cr.
You might think: Hey – we are borrowing 106,000 cr. to pay back people we had borrowed from earlier? Isn’t that ponzi? Welcome to the world of government financing. And indeed most capital market finance.
Our GDP was 61,64,178 cr. in 2010, and we expect it to grow to around 69,30,000 cr. in 2010-11. That’s an additional 800,000 cr. in GDP that the entire country will do; while there’s no sense comparing incremental government debt to GDP growth figures, it gives you an idea of the scale of government borrowing.
(Note that this looks very good when applied, for instance, to western countries. The US will probably need to borrow $2 trillion. If they do REALLY well, they will grow about GDP by $700 billion.)
Also we’re slightly better off than countries abroad in terms of debt to GDP, but our interest payments are WAY too high. (20% of revenues is not a good thing – the US is at 5-7% and they are getting worried)
So what is the effective interest rate we pay? Overall, our payout is at 8% (considering all maturities). On a maturity year basis:
The most expensive debt is maturing in the next two years – at around 9.75%. If we are able to roll this over to say 8% yields, we’ll save about 3,500 cr. in interest on the same amounts. Look then at the distribution (the ultra low figures are floating rate bonds)
The size of the bubbles is the amount of debt outstanding. We have a small amount of leftover debt from really long back, at high rates; ignore those. But above 10% you notice a few large bubbles maturing in the next four-five years – those hurt us the most, and we need to roll them over at lower rates. But since the RBI is on an interest rate RAISING cycle, and inflation is already at 10%, it’s going to be a tug of war between RBI’s raising rates and the government balking from paying higher interest when rolling loans over.
A significant chunk of borrowing matures in the 2015-20 timeframe, and I’d imagine we have two choices – either have high inflation and thus devalue this debt to the point where it’s easy to pay back (remember, all this debt is in rupees) or scale to a current account surplus so we don’t need to refinance most of it.
The next year will be tough for the RBI – for controlling inflation and placing government bonds. In an environment where private players are willing to pay more and are now strong, government debt placement will be even more difficult, unless we let foreigners hold our debt. But if we do, that screws up the rupee-dollar equation; like I said, tough year for the RBI. A crisis of any sort, and we have to get back to the drawing table. (If we ever left it)
I presume this will be an ongoing task to keep the outstanding debt profile mapped. I’ll try and make a post every month, keeping a tab of all new issuances, maturities and buy backs.
A equity fund that’s like a debt fund: Arbitrage opportunities
How would you like to invest in a fund that gives you:
a) better returns than liquid funds
b) same risk as a liquid fund
c) much better tax treatment than a liquid fund
a) better returns than liquid funds
b) same risk as a liquid fund
c) much better tax treatment than a liquid fund
I can see you raising your eyebrows in suspicion. No this is not a get rich quick scheme, and will not loot you of your money.
You should consider buying an arbitrage fund like SBI Arbitrage Opportunities fund.
Reason: It has given around 2.88% in the last three months, which is higher than liquid funds. Second, the risk profile is like that of a liquid fund - i.e. no capital risk at all, since it invests only in arbitrage opportunities.
Third, the capital gains tax on an arbitrage fund is much better than a debt fund - it is only 10% of your gains if you ditch the fund less than a year, and 0% for more than one year. Reason is: This fund invests in equity arbitrage, so it gets the benefit of an equity fund, with the risk profile of a debt fund.
Firstly let me explain the concept of arbitrage in this case. A stock that is traded in the futures markets - let's say Infosys - usually has a slightly different price on the futures market versus the cash market. So if the futures price is Rs. 1975, and the cash market price is Rs. 1950, then you can buy in cash and sell the future. That gives you Rs. 25 per share, risk free - regardless of which direction the price moves.
Say the price on the date of expiry is Rs. 2,400 (huge increase). The future sale will be a loss of Rs. 425 per share, but you also sell in the cash market and make profit of Rs. 450 per share. The result: Rs. 25 profit. If the price is Rs. 1600, you make Rs. 375 profit on the future, Rs. 350 loss in the cash market. Still, Rs. 25 profit. So it's risk free.
That is an example of course; your results may vary. But why can't you do this yourself instead of going to a fund house? Because the margins required to do this are pretty big - buying a 100 lot (minimum lot size for Infy) in the cash market needs about 2 lakhs of cash, and to sell in the futures market requires about half that. So 3 lakhs, to make 25x100 = Rs. 2500 profit. You may not have that kind of capital available.
In the last few months arbitrage funds have made about 9-10% annualised, and the tax benefit allows you to get a better return. If you invest in a liquid fund, it would give you around 9% annualised, purely because dividend tax is high (around 28%) and capital gains tax is around 30% (your investment bracket). Taking 30%, your net return, if you want to exit within a year, is around 6.3%.
Arbitrage funds, being equity funds, allow you to get a better capital gains tax - which is 10% short term, and 0% long term - and that means a 9% return translates to a 7.85% return within a year. (including 0.25% STT)
What's the downside? (There is always a downside)
You can buy this fund anytime but you can redeem or sell it only on the last thursday of the month (futures expiry date). If you give your redemption order before that, you will money only on that date or a couple of days after it. It's not as liquid as a liquid fund, but if, like me, you are ok with getting your money at the end of the month, you should be ok.
There is no entry load. There is an exit load if you exit before six months - typically 0.25% or so. Also there is STT applicable, again, 0.25%. Even if you consider that you make more money with arbitrage funds, with the same low risk, than liquid funds. You sacrifice a little liquidity, and your returns are not guaranteed.
This may even be better than long term FMPs, which give you the above advantages of lower tax since they span financial years, but you have to hold till maturity (or pay a large penalty).
Links: SBI Arbitrage Opportunities fund
Also read Money Today's informative article.
Liquid Funds are better than Fixed Deposits
The increase in Dividend Distribution Tax (DDT) in Budget 2006 has been touted as a big issue. Specifically on liquid funds and money market instruments, where the Finance minister increased DDT to 25%, to "plug an arbitrage" between them and bank fixed deposits. The thing was - DDT for liquid funds was 12%, so obviously people chose that over a fixed deposit where you would pay tax on all income at your marginal tax rate. So the increase to 25% would make bank deposits more attractive.
Meaning, if you earn more than 2.5 lakhs a year, you would pay 30% (+3% cess = totally 30.9%) on income from a fixed deposit. Liquid funds which usually pay out dividend often (weekly, daily) now have to pay 25% on the amount they distribute, plus 10% cess and 3% education cess (28.325% in total).
But I maintain that even with this, you pay far lesser for a liquid fund than you do for fixed deposits, if you make more than 2.5 lakhs a year. Here's how.
Let's assume that you invest Rs. 10,000 in either avenue. And let us say both earn the same return - 10% per year.
In an FD, you will get Rs. 1000 as interest. And you have to pay 30.9% of this as income tax - that's Rs. 309 gone - and you're left with Rs. 691. That's an effective return of 6.91% for the fixed deposit.
Now let's say a liquid fund (which you bought 1000 units at Rs. 10 NAV) earned Rs. 1000, which means the NAV stands at Rs. 11 today. Now the liquid fund wants to pay out Rs. 1000 as dividend. Does it declare Rs. 1000 as dividend and pay 28.325% dividend tax? No!
The NAV will drop down after paying dividend. How much is required so that the NAV comes down back to Rs. 10 (so that your "principal" is maintained)? They will declare Rs. 7.79 as dividend per unit. The DDT for this is Rs. 2.21 which they pay the government.
Let's see how much you make, for your 1000 units. You get Rs. 779 as dividend, which means a net yield of 7.79% for a liquid fund.
The tax advantage is obvious: At 10% gross return, you pay Rs. 30.9% tax for a fixed deposit and only 22.1% tax for a liquid fund.
And another benefit is penalties - if you pre-close an FD, you will lose some of the interest because they will give you a lower rate for the period you used. Liquid funds have no such penalties and you get the full interest for all the money you use.
Note though, that liquid funds have varying yields based on the rate of interest currently in the market. FDs freeze the interest rate. Therefore, in a regime where interest rates are coming down, it is perhaps better to use an FD to lock in a higher interest. But at this point the interest rates are going up, and liquid funds are a better alternative there too - as the increase in rate will immediately reflect on your return.
The only advantage of FDs is the fact that you get money post DDT. So for the example you see only Rs. 779. Banks only deduct 10.3% TDS, so you would see Rs. 897. But of course you'd have to pay tax later anyhow.
Why would you choose a fixed deposit in this scenario? One reason can be that liquid funds don't want investments less than Rs. 50,000. But that's just the first entry, subsequent purchases can be of much lesser, Rs. 10,000 or so. If you can gather the initial Rs. 50,000 - even temporarily borrowed - you can stay in and get a better return.
For corporates this is even better - they pay 33.99% tax on other income, but dividends are tax free. Liquid funds which effectively have lower tax still outperform bank fixed deposits. So much for plugging the arbitrage!
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