What does the Union Budget 2003 have in store for retails investors? This is a question upper most in the minds of millions of investors.

We have put down some of the key provisions of the last budget pertaining to various investment products like fixed deposits, small savings schemes, mutual funds, government securities (g-secs) and bonds. We have then given a brief outline on what an investor can expect in the coming budget, to be announced later this month.
 

Fixed Deposits
What has happened|
Falling interest rates have seen fixed deposits (FDs) rates getting less and less attractive. Both banks as well as companies have consistently cut down their deposit rates. Quite a few companies have even stopped accepting fresh deposits altogether. Fundamentally strong companies i.e. AAA rated, do not offer rates exceeding 9% p.a. Moreover, interest income from these deposits is taxable, apart from housing finance companies, which give tax benefit u/s 80L (income exempt upto Rs 9,000). Bank deposits are still popular among retails investors. The reason being that they not only give tax benefit u/s 80L but also because the government is a guarantor for deposits upto Rs 100,000 on behalf of the bank for the deposit holder.

What you can expect|
The falling interest rate regime, which is likely to be sustained, will see further cuts in deposit rates. In the last budget, section 80L benefit was reduced from Rs 15,000 (additional Rs 3,000 for investments in g-secs) to Rs 9,000 plus the additional Rs 3,000 for investments in g-secs. If the government accepts the recommendations of the Y. V. Reddy committee, section 80L will be deleted or at least the benefit of Rs 9,000 may be brought down further. If this happens, investors will have to look beyond fixed deposits for parking their investable surplus.
 

Small Savings Schemes

What has happenedâ¦
The finance minister had slashed rates on small savings schemes like NSC (National savings scheme) and PPF (Public provident fund) in the last budget. However, these still make very attractive investments due to their high returns, safety and tax benefits. NSC gives a return of 9.5% p.a. for 6 years and tax benefit u/s 88 (20% rebate) and sec 80L (interest income), along with the highest safety as it is backed by the government. PPF is also attractive as it gives tax-free return of 9.5% p.a. for 15 years upto a maximum investment of Rs 60,000 p.a. However, PPF has recently lost its sheen as the government brought its overall investment limit to a total of Rs 60,000 p.a. Earlier it was high as the investor could invest in his own name and on behalf of his children, wife and association of persons and take the advantage of tax-free returns.

What you can expect¦
There are mixed reactions on whether the government will further cut the rates on both NSC and PPF. The government has maintained the EPF (employers provident fund) rate at 9.5% p.a. and there is a view that it should remain at that level. Then again, given the fact that the government is grappling with a fiscal deficit shooting up by 18.4% in just 9 months, a rate cut could well be in the offing. Moreover, if the government accepts the recommendations of the Y V Reddy committee to remove the benefits under section 88, it could kill interest in both NSC and PPF where the tax benefit is a major driver. Also if PPF goes into the floating rate mode (which was one of the recommendations) and is linked to the g-sec rate of the same maturity, PPF returns would decline dramatically. (The yield on a 10-year g-sec is currently hovering below 8% p.a.)

Mutual funds
What has happened¦
Currently, dividends from mutual funds (debt and equity schemes) are tax-free in the hands of investors. This has given a fillip to debt fund inflows, more so as debt fund net asset values (NAVs) witnessed a dramatic surge in response to the interest rate and CRR (cash reserve ratio) cuts effected by the RBI over the last year.
 

What you can expect¦
In the last budget, the finance minister reduced the dividend distribution tax on income funds. As expected, that gave a boost to debt fund inflows. Given that the mutual fund industry is struggling to find a direction, dividends are expected to continue to be tax-free in the hands of investors. An attempt to change that could prove detrimental to the industry's growth prospects.

Government securities and Bonds

What has happened¦
G-secs are fast becoming more popular and more available to the retail investor. The demand for g-secs (and g-sec funds) has risen dramatically but the supply in these instruments (catering to the retail investor base) is still very low. Under section 80L, interest income upto Rs 3,000 from g-secs is exempt from tax.

As far as investments in bonds are concerned, the 8.5% RBI Relief Bonds score highly with retail investors. Today, it is the only fixed income instrument, which gives 8.5% p.a. tax-free returns for 5 years along with highest safety as these bonds are backed by the Government of India.

What you can expect¦
With g-secs now also available for retail investors this market is growing at a fast pace. The total gross borrowings of the government from the market over the past few years have increased significantly. It was announced in the last budget that a screen-based terminal would be set up for real time dealing in g-secs. These terminals are not yet available to the retail investor, however progress on the same is going on and the terminals should be made available by this year. On the tax front, the finance minister may increase the exemption limit on interest from g-secs to invite more retail participation in this market.

With RBI Relief Bonds, there is some talk in the market over the past few months of a rate cut in the coupon rate from 8.5% p.a. to 8.0% or further down. The Y V Reddy committee had recommended doing away with these bonds altogether. If the government accepts the committee's recommendations, either a fresh issue of relief bonds can be ruled out altogether or the existing rates (8.5%) will be reduced in line with market rates.

Over the last year or so the interest rates offered by investment options available to the low-risk-appetite investor have declined significantly. Going forward, one should factor in a persistent decline in yields offered by most instruments. Investors, who depend on such instruments, need to plan well to cope with a scenario where there income from instruments bearing a fixed return could be dramatically reduced.

 

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