IDFC Infrastructure Bond Issue

Every week, we look at equity related offerings. This week, lets step aside and look at some debt offering. IDFC is coming with an Infrastructure Bond issue which closes on October 18th 2010.
The government has issued a notification that an additional amount of Rs 20000 can be invested in, other than your limit of 1 lakh rupees under section 80. This means this Rs 20000 will be exempt from your taxable income this year. Depending on which tax slab you fall under, 10 %, 20% or 30 %, you will save additional income tax of Rs 2000, Rs 4000 or Rs 6000 respectively. (I am not computing the surcharge amount- the real rate of taxation can be 10.3%, 20.6% or 30.9%)
In addition to this, you get 4 different options of investment as below. The bonds have a lock-in period of 5 years and have a maturity period of 10 years. 2 options are cumulative ones and 2 are annual interest options. For the bods yielding 7.5%, after 5 years the company will give a buyback option and for those yielding 8 pc no buyback option.

I would invest in the 8 pc option bonds as even if there is no buyback option, the bonds are listed on the NSE and can be traded after the lock-in of 5 years.
IDFC is a triple A rated paper, interest rate of 8 pc, along with the tax benefit makes these bonds one of the best investment options going around.
Please note the interest is taxable and will attract the normal rate of taxation. With the tax break the real return actually works out to as high as 12-14 pc pre-tax.
Also, even though the benefit of tax breaks is only 20000 rupees, one can invest higher amounts. The 10 year bond yield is around 8 pc.
At current market valuations, debt is another option one must look at as interest rates may peak after maybe another 100 basis points hike. Bond yields and bond prices are inversely proportional. When rate cuts come in, bond prices rise and the returns in those years can be as high as 20 pc.
L&T NCDs are listed on the NSE and those are another good option for those looking at good quality paper, liquidity and decent returns.
Our asset allocation should not only be equities, but also gold, debt and other asset classes. I am not a big fan of real estate investment other than place where I live simply for the myriad red tapism, difficulty in disposing and the procedural hassles. I prefer assets where I can liquidate and get cash in max 3 days.

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How the European Woes Affect All of Us

Over the last few weeks, Greece and the so - called PIIGs countries of Europe have been under the spotlight. Let us examine what is the European Union, why the debts of certain member countries are a threat to all and the way going forward.
The roots of the European Union can be traced to the period after the Second World War and the rebuilding of Europe. For those who are interested in reading further, wiki has interesting nuggets:
http://en.wikipedia.org/wiki/European_Union
The EU has a membership of about 27 nations. It is somewhat like Federal Structure of India where weak states are subsidized by the stronger states. This is the reason why in India, the so-called BiMaRu belt ( Bihar, Madhya Pradesh and UP) even if they were not doing well earlier, the other states made up for it.
Now, Greece, Spain, Italy, Ireland and Portugal have ran up huge debts mainly due to lack of earnings and huge spending.
The confidence in Greece's ability to pay up led a run on their bonds (debt). No one was willing to lend to Greece as they thought in case of a default, the institutions issuing the debt would loose their money.
If there was no Euro, and the Greece Drachma, the problem would have been limited to Greece, there would have been sympathetic noises made and the world would have moved on. Greece is part of the EU and has the currency Euro.EU cannot allow its member nation to fail in debt obligations, because that would mean the end of the Euro and the EU. No one would trust the Euro anymore.
The problem further stems from the fact, that the stronger countries like Germany were not too willing to bail out Greece. The reason? Taxpayers of Germany feel why should the Greeks party and we pay the bill for the party.
The same situation prevails in the other PIIGs nation. The following image got from the web, shows the magnitude of the debt.
The problem with the EU and the Euro is that it is an artificial nation and currency created without clear cut mechanisms, to cut fiscal deficits.
Now, how would this EU crisis affect other nations:
1. EU has 21% of the World's GDP. It is the largest trading partner to the countries like China and India.
2. A weak Euro hurts exports from India to EU.The margins get hit. If there is less demand in EU, the exports get hit anyway. Prime example our Automakers namely Maruti and Hyundai exports big volumes of cars to EU.
3. The Dollar Index has already moved up to 86 from 74. A strong Dollar means the end of the Dollar Carry Trade and the hot money moves out from the Emerging Economies and moves back to the US.

The next few months and how the EU crisis pans out will show us where our markets will go.
To think of it, it was only in last year where the talk was that that the Euro would replace the USD as the world's premier currency.

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