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Business News/ Market / Mark-to-market/  Fixed maturity plan move may push money to bank FDs
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Fixed maturity plan move may push money to bank FDs

Treasurers expect money to flow from debt funds to bank FDs over the next one year, generating liquidity in the banking system

Till now, companies used to park excess cash in FMPs for higher post-tax returns. Photo: Pradeep Gaur/MintPremium
Till now, companies used to park excess cash in FMPs for higher post-tax returns. Photo: Pradeep Gaur/Mint

Mumbai: With the Union budget taking away the tax advantage enjoyed by debt funds, corporate firms that used to invest in fixed maturity plans (FMPs) offered by debt funds may switch to fixed deposits (FDs), making it easier and cheaper for banks to raise funds, bank treasurers said.

Treasurers expect money to flow from debt funds to bank FDs over the next one year, generating liquidity in the banking system in the process.

Till now, companies used to park excess cash in FMPs for higher post-tax returns. FMPs, in turn, invest most of the money in short-term money market instruments such as bank certificate of deposits (CDs).

The Union budget presented on 10 July proposed to remove the indexation benefits of non-equity mutual funds and set a threshold of three years to claim long-term capital gains status, effectively bringing them on par with FDs for tax purposes.

Banks’ borrowing costs have edged up over fears that plugging the debt fund loophole could take sheen off FMPs and reduce demand for bank CDs. Banks are currently offering 9.06% interest for 12-month CDs, up from 8.9% at the end of June, while the rate for six-month CDs has moved up to 8.9% from 8.75% at the end of June. Bankers, however, say any fall in demand for CDs will be balanced out by direct inflows into bank FDs.

“It is true that FMPs are no more attractive, and hence, demand for CDs may wane. However, since the tax treatment for both FMPs as well as FDs is the same, companies may, in fact, prefer to directly keep money with the bank, which in itself will reduce our dependence on CDs," said N.S. Venkatesh, treasurer at IDBI Bank Ltd.

Banks had raised 3.22 trillion from CDs till the fortnight ended 13 July, Reserve Bank of India (RBI) data showed. Jaideep Iyer, group president, financial management, Yes Bank Ltd, said almost all of this money will directly flow into the banking system through FDs in the next few months.

“There was a tax disparity between FDs and FMPs, which has been addressed. In my view, currently, FDs are more attractive because unlike closed-ended funds like FMPs, pre-maturity withdrawal is allowed and some banks do not charge customers for such withdrawal," Iyer said.

Investors cannot withdraw funds prematurely from FMPs because they are closed-ended schemes. However, an investor can sell these investments which are listed on the local stock exchange, provided there is a buyer.

Arun Khurana, country head, global markets group, IndusInd Bank Ltd,said the market will eventually learn to adjust to the new scenario.

“Maybe companies which want to keep cash for extremely short tenures will invest in liquid funds. But one thing is certain that more money will flow into bank deposits," he said.

More money into deposits will mean more liquidity and hence more money available for lending, said Vaibhav Agrawal, vice-president, research, Angel Broking Ltd.

“This is a positive move for banks because we are potentially looking at at least 2 trillion to come into deposits, which could potentially make FDs cheaper and provide more money for lending," Agrawal said.

For companies, the choice between investing in debt or keeping funds in bank FDs has become more “neutral" according to Prabal Banerjee, president, international finance, Essar Group.

“The future of FMPs is now under a cloud, while at the same time prospects for bank FDs have got better. Companies may now prefer FDs because it will help them maintain their banking relationships and also are more liquid compared to FMPs," Banerjee said.

Post-tax returns on FMPs were higher than FDs because investors who parked their money for one year or more in non-equity schemes got the benefit of indexation and were taxed at 10% compared to a much higher corporate tax rate for FDs.

Indexation is an accounting standard where the cost price of FMPs were inflated every year in such a way that at the time of redemption, the cost price becomes more than the selling price. No profit—accounting-wise—meant no taxes to pay, making such investments attractive.

Union Budget 2014 got rid of this tax arbitrage and stated that investments held in non-equity schemes would qualify for long-term capital gains only after three years (36 months), up from a year earlier.

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Published: 15 Jul 2014, 11:34 PM IST
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