For nearly a decade, Tax-Free Bonds issued by Public Sector Undertakings (PSUs) have been the crown jewel of HNI (High Net-Worth Individual) portfolios. Companies like NHAI (National Highways Authority of India), IRFC (Indian Railway Finance Corp), REC, PFC, and HUDCO raised thousands of crores between 2011 and 2016 to fund India's infrastructure.
The unique selling point? The interest you earn is 100% exempt from tax under Section 10(15)(iv)(h) of the Income Tax Act, 1961. Unlike FDs or Debt Funds where returns are taxed at your slab rate, what you see here is what you keep.
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Compare Tax-Free Bonds vs Fixed Deposits (FDs).
To beat this bond, you need an FD paying more than 7.57%.
1. The "Yield Illusion": Why 5.3% is better than 7%
If you log into your broker account today, you might see an NHAI bond trading at a yield of 5.30%. A naive investor might dismiss this, thinking, "My bank offers 7.25% on FDs."
This is a classic mistake. You are comparing a Post-Tax Return with a Pre-Tax Return. For an investor in the 30% tax bracket (plus cess), a 7.25% FD effectively returns only ~5.0% in hand. The Tax-Free bond, yielding 5.30%, is the clear mathematical winner.
2. Why are they so expensive? (The Scarcity Factor)
The Government of India stopped issuing fresh Tax-Free Bonds in 2016. The Ministry of Finance realized they were losing too much tax revenue. This has created a situation of permanent scarcity.
According to NSE Market Data, the existing pool of bonds is shrinking every year as old issues mature.
- 10-Year Issues: Most bonds issued between 2011-2015 with 10-year tenure have already matured and extinguished.
- 15-Year Issues: These are currently maturing (2026-2030).
- 20-Year Issues: These are the only ones with significant remaining life (maturing 2031-2036).
This "vanishing supply" means holders are reluctant to sell, driving prices up and yields down.
3. The "Step-Down" Clause: A Hidden Trap
When these bonds were originally issued (IPO), they often had a special clause: "Retail investors get 0.50% extra interest."
For example, NHAI might have offered 8.50% to Retail investors (holding less than ₹10 Lakhs) and 8.00% to HNIs.
The Warning: If you buy these bonds in the secondary market today and your total holding exceeds the retail limit (usually ₹10 Lakhs face value), you lose that retail privilege. The interest rate on your bonds will automatically step down by 0.50%. Always check the ISIN details on the BSE Debt Segment before buying in bulk.
4. How to Buy Them? (Secondary Market Guide)
Since there are no new issues (Primary Market), you must buy them from the exchange (Secondary Market) like a stock.
Step-by-Step:
- Login to Demat: Use Zerodha, Upstox, or HDFC Securities.
- Search by Name: Type "NHAI", "PFC", or "REC" in the search bar. You will see codes like
N2,N3,N6. These denote different series (maturities). - Check Liquidity: Tax-free bonds are illiquid. Use "Limit Orders" only. Never place a "Market Order" or you might buy at a absurdly high price.
- Settlement: The bonds will appear in your Demat account in T+1 days. Interest will be credited directly to your bank account annually.
5. Risks You Must Know
Also, remember Interest Rate Risk. Being long-duration bonds (10-15 years remaining), their prices are very sensitive to RBI rate changes. If interest rates in the economy rise, the market price of your bond will fall temporarily (though your interest income remains safe).