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Imagine you are a student who wants to pursue higher education abroad, but you lack the funds and scholarships to do so. You approach a relative who offers you a loan with a low-interest rate and a flexible repayment plan on the condition that you use the money for education only.
This is how social bonds work, in a nutshell. They are a way of financing projects that have a positive impact on society and the environment while also offering financial benefits to the issuers and investors.
In today’s article, we will cover the basic points of social bonds, the recent update on India’s social impact bonds, and the risks and benefits associated with the investment.
What are social bonds?
Social bonds, often referred to as social impact bonds and shortened as SIBs, are bonds whose issuer chooses to use the money raised to support a project that may have some beneficial impact on society.
Buying a social bond, like purchasing any other bond, makes the bondholder the creditor of the bond issuer, who is, in turn, indebted to the bondholder. Put simply, the bond issuer uses the money for a project that advances the greater good of society, and the bondholders lend money to them.
These bonds fund initiatives that address a range of social challenges, including alleviating poverty, cost-effective housing, medical treatment, higher education, and protecting the environment.
The governing body may later invest in the projects after observing the objectives are fulfilled, thanks to these results-based funding arrangements, which provide social benefits upfront.
Social bond examples:
In 2020, together with the United Nations Development Programme (UNDP), the Pimpri Chinchwad Municipal Corporation (PCMC) of Maharashtra issued India’s first Social Impact Bond (SIB).
NABARD’s take on social impact bonds in India
On September 26, 2023, the National Bank for Agriculture and Rural Development (NABARD) announced the issuance of its first social bonds, totalling over ₹1,000 crore. This is India’s only externally verified AAA-rated social bond.
Each bond has a face value of ₹1 lakh and is an unsecured social security that is redeemable, subject to taxation, non-convertible, and non-priority sector.
The bonds were listed on the Bombay Stock Exchange in late September 2023 after being privately offered to acceptable institutional investors. The bonds are redeemable in September 2028. Investors need to make coupon payments annually and must retain them for a total of five years.
The social bonds had a ₹1,000 crore base issue size and a ₹2,000 crore retention option for oversubscription. Despite receiving bids totalling ₹8,590.50 crores, NABARD claimed it only accepted ₹1,040.50 crores at a 7.63% coupon rate.
To further support qualifying new and current social initiatives, NABARD has announced the launch of the Sustainability Bond Framework. The new kind of bonds that NABARD is introducing would also be able to support energy-efficient projects, such as smart grids, energy preservation, and sustainable construction.
Why do investors prefer social impact bonds?
The same emotion that motivates investors in sustainable stocks and green cryptocurrencies drives them to invest in social bonds. Each rupee invested adds up to the capital that the government or business issuing the bond would need, and most investors understand this, regardless of how little their investment may be compared to others.
The investors, for this reason, won’t just pick any bond with a low default risk and a reasonable interest rate; they look for a bond with a low default risk and an attractive interest rate where the company releasing the bond plans to use the money from its proceeds to do something benefiting society.
Risks and benefits of investing in socially responsible bond funds
Default risk is inherent in each bond, just as it is in the stock market, since there is a chance of full or partial project failure. It is crucial for investors to be familiar of the advantages and drawbacks of investing in social bonds.
Positive aspects:
- The investor has the chance to make a positive change in the environment and society.
- For the first time, the government has a way to finance and bridge the deficit.
- In some cases, social bonds may even provide tax benefits to the investor.
Negative aspects:
- Potential investors stand to lose money if the government endeavour fails.
- Partial payouts of face value and interest are possible.
- It is possible to amend bond arrangements to give the issuer extra time.
Conclusion
Social bonds allow investors to fund positive social initiatives while generating profits. Though risks exist, the growth of these bonds shows demand for ethical projects. However, before investing, investors should give these securities ample consideration and research as much as they can about the project’s prospects.
FAQs
Indian government bonds are generally considered safe investments as they are backed by the sovereign guarantee of the government and have a low default risk. However, they are also subject to interest rate risk and inflation risk, which may affect their returns.
AAA-rated bonds are the highest-rated investment-grade bonds, which indicates that the issuer has excellent creditworthiness and is highly likely to repay the bond on time and in full. AAA-rated bonds have the lowest default risk and the lowest interest rate among corporate bonds.
NABARD bonds are not tax-free, but they offer some tax benefits to investors. The interest income from NABARD bonds is exempt from TDS. However, the principal amount invested in NABARD bonds does not qualify for tax deduction under Section 80C.
Different public sector undertakings (PSUs), such as NHAI, NABARD, and others, issue tax-free bonds at a predetermined coupon rate to raise money for a specific purpose over a fixed tenure. The interest income from these bonds is fully exempt from income tax under the Income Tax Act of 1961.
Investing in AAA bonds offers low-risk and stable returns
AAA bonds have the lowest default risk and highest creditworthiness
AAA bonds offer a steady income with interest rates of up to 7%
AAA bonds are highly liquid and easy to trade
AAA bonds diversify portfolio and provide stability