Whether you're a risk averse investor looking to maximize safety or just anyone who wishes to hedge their portfolio, bond investments are a great option to explore. It ensures regular fixed income and isn’t nearly as risky as equity investments.
But this is not to say that it doesn’t come with its own set of rules, risks and restrictions. Here’s a deep dive into what investing in corporate bonds means for an NRI.
What is a Bond?
Bonds are debt instruments which are issued by governments or corporations to raise funds. They are usually issued at a discounted price and investors get interest on them. On maturity, the investors get the full amount of the actual value of the bond. Unlike with stocks, where you own equity in the company and will receive dividends declared and paid by the company. In bonds, you don’t buy ownership or get dividends. You simply lend your money, and in return, the company pays you interest regularly and returns the principal when the bond matures.
Bonds as Debt Obligations
As bonds are legal debt obligations, the company must make interest and principal payments on time, even if its financial health is failing. For a government bond, there is no risk of the government defaulting on the amount. In the event of a bankruptcy, bondholders get priority over shareholders when it comes to asset claims. That’s what gives bonds their reputation for being safer than equities.
Can NRIs Invest in Bonds in India?
Yes, NRIs are allowed to invest in bonds in India but with some restrictions. NRIs are permitted to buy government bonds, public sector bonds issued by government-backed entities as well as certain corporate bonds. It is to be noted that, most direct private sector corporate bonds are off-limits for NRIs due to regulatory restrictions. However, NRIs can indirectly access these bonds through debt mutual funds on which they have no restrictions.
Types of Bonds Available for NRIs
1. Government bonds
These bonds are issued by the RBI. They include G-Secs, State Development Loans (SDLs) and treasury bills (T-bills). Given they have sovereign backing they are considered the safest debt investment. NRIs are not permitted to invest in sovereign gold bonds (SGBs) or floating rate bonds.
2. PSU bonds
Issued by public sector companies, the interest earned on these bonds is tax-free as per Section 10(15)(iv)(h) of the Income Tax Act. They are an ideal option for those who seek moderate and stable returns.
3. Capital Gain Bonds
These bonds also known as Section 54EC bonds are specifically useful for NRIs who want to save on capital gains tax. If you invest the profit from a long-term asset sale like property in these bonds, you can avoid paying capital gains tax. But you need to invest within 6 months of the sale, and the money will stay locked in for 3 years. There are however only a limited number of eligible issuers like REC (Renewable Energy Corporation) and NHAI (National Highway Authority of India).
4. Corporate Bonds
NRIs can only invest in Non-Convertible Debentures (NCDs) issued by private companies. These bonds cannot be into shares. Although they offer higher yields, they come with some credit risk. However, there is a very limited number of corporate bonds which NRIs can invest in directly. They would need NRE/NRO accounts to invest in these bonds.
5. Debt Mutual Funds Investing in Corporate Bonds
These are debt mutual funds. They are mandated by SEBI to invest at least 80% of their portfolio in high-rated corporate bonds. This route allows NRIs to gain indirect exposure to both PSU and private sector bonds. It offers diversification and professional management, which helps manage the risk.
However, one needs to note that NRIs based out of the US and Canada can only invest in certain mutual funds that comply with FATCA regulations.
6. Bonds through GIFT City Exchanges
GIFT City is India’s international financial services special economic zone (SEZ) located in Gujarat. Bonds are listed in two of the international exchanges, i.e., NSE IX and India INX. The bonds available in GIFT City exchanges are foreign currency bonds, ESG bonds, and Masala Bonds. GIFT City provides an alternate route for NRIs looking to invest in Indian bonds.
ESG and foreign currency bonds are denominated in international currencies like USD, SGD, JPY etc. Masala bonds are denominated in INR.
Indian entities like ICICI bank, Shriram Finance, Adani Ports etc. have issued their USD and INR denominated bonds in the GIFT City exchanges. ESG bonds allow investors to fund initiatives that finance social and environmental projects.
What are the Risks of Corporate Bonds for NRI?
The government-issued bonds are largely risk-free as they are issued by the government. There is very little chance of the government not honouring its debt obligations.
Although Corporate bonds are typically safe investments, there are a few factors for NRIs to consider:
1. Credit Risk
This is the risk that a company won’t be able to make its payments. With corporate bonds this risk is higher as they are not backed by the government as in the case of government bonds or PSU bonds.
Debt mutual funds investing corporate bonds are professionally managed by fund managers who usually choose AA or higher-rated bonds to limit this risk.
2. Interest Rate Risk
Typically when interest rates rise, the price of bonds tend to fall. This is not a problem if you plan to hold the bond until maturity. However, if you need to pre-maturely sell the bond, interest rate movements can affect the resale value.
3. Liquidity Risk
Although it’s gaining much traction, the bond market in India is not as active as the equity markets. This may make it harder to sell a bond quickly or at the price you want. However, corporate bonds via mutual funds offer easier exit routes even though their NAVs can still fluctuate with market conditions.
4. INR Depreciation
If you are planning to repatriate your investment to a foreign country, exchange rate movements can significantly affect your returns. A weakening rupee can reduce your effective return when it is converted back.
Tax Treatment and Repatriation Rules on Bonds for NRIs
1. On Interest Income
The interest earned on the bonds is taxed according to the slab rate of the individual.
2. On Capital Gains
Capital gains are calculated when one sells their bond holdings. The capital gains tax on bonds for NRIs depends mainly on the holding period:
The gain is considered short-term capital gain and is taxed at 20% if you hold the bond for less than 24 months.
The gain from selling the bonds after 24 months is considered long-term and is subject to a flat 12.5% tax rate (plus surcharge and cess).
3. GIFT City Bonds Taxation
Interest income on bonds issued after July 1, 2023 is taxed at 9%. Interest income for bonds issued after 1st April 2020 and before 1st July, 2023 are taxed at 4%.
There is no capital gains tax on selling these bonds.
An important point to note here is the Double Taxation Avoidance Agreement (DTAA) that India has with 85+ countries. Some of the countries may have special rates of taxation for bonds which might be lower than Indian interest rates.
4. Repatriation Rules: Can you take the money home?
Repatriation rules depend on the account from which you make the investment.
- Bonds invested through an NRE (Non-Resident External), can be fully repatriated back to your country of residence after currency conversion.
- Investments made from an NRO account are non-repatriable by default. However, NRIs are allowed to repatriate up to USD 1 million per financial year given they get tax clearance and follow the RBI guidelines.
Are Bonds Worth Exploring for NRIs?
Bonds offer a way for NRIs to earn predictable returns from India’s growth. They may not be flashy but they do deliver returns with a very reasonable level of safety.
The options of corporate bonds are limited for NRIs. Debt mutual funds investing bonds offer a good way of getting exposure to bonds in your portfolio. Other than that GIFT City exchanges offer a way of participation in the bond market without much paperwork.
But before you invest, decide on your investment goals, understand the risks, repatriation rules and taxation policy.
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