Will tax-free bonds save US-64?

MUMBAI: For over eight million US-64 unitholders, the Unit Trust of India has doled out enough incentives for them to stay on with the scheme even after the government-assured redemption package, scheduled to expire on May 31, takes effect.
To start with, these investors have been offered 6.75 per cent tax-free bonds coupled with benefits of tradeability, though there will be few sellers in the market, except for someone who is in dire need of cash.
This means that US-64 investors will fetch returns up to 10.64 per cent (those who belong in the 35 per cent income-tax bracket), which will leave investors with no option but to convert the units into five-year bonds. These bonds expire on June 2008.
However, debt traders said that trading on US-64 bonds, with a face value of Rs 100, will kick off with a marginal premium as there will be less institutional interest on these papers due to non-availability of market lots. "These bonds will be like those stand-alone bonds which have unique characteristics and cannot be linked to a similar-profile government security, especially in terms of price discovery," said a Birla Sunlife fund manager. A 2008 maturing government paper is being traded at 6.33 per cent yield.
A UTI official said that this move will stop redemptions tremendously because a bank deposit for 5 years will fetch an investor much less returns and that there is no alternative for him, but to opt for these bonds.
"Over 80 per cent of the US-64 asset class (in terms of value) belongs to the top income-tax bracket and these investors will gain a hefty return of 10.38 per cent for a five-year instrument.
This means that none of these investors will be keen to sell their units unless there is a dire need and for that reason there will be very few sellers in the market. UTI doesn’t intend to prove any market-making mechanisms for this product and may not even list these bonds on the exchanges," he said.
As on date, transaction worth only a few lakh have been reported on the US-64 counter ever since UTI allowed trading on January 28, with the current bids being quoted at Rs 9.60, said sources.