Why to invest in Kisan Vikas Patra?

Due to the current low-interest rate regime, small savings instruments have once again started looking attractive. KVP is also a small saving instrument available at post offices offering a pre-tax return of 8.41% per annum (your money doubles in 8 years & 7 months).

Basic Features:

1. Easy to purchase: Available in denominations of Rs 100, Rs 500, Rs 1000, Rs 5000, Rs 10,000 and Rs 50,000. No a/c opening hassles are involved. Just go to a post office fill a form, hand over the cash or cheque / DD and you’re done. Further there is no limit as to number of KVP certificates you can purchase or maximum amount you can invest.

2. Post-tax Yield: The interest is taxable on annual basis (although no TDS is involved). The post-tax yield from KVP depends on the marginal tax rate that will be applicable to you.

3. Premature encashment is possible just after 2.5 years (2 years & 6 months) but it is very costly—see the table:

Period————————–Yield—————Reduction in Yield

Up to 2.5 years —————–NA————————–NA

2.5 years to 3 years————-6.5%———————–1.91%

3.5 years to 4.5 years———–7.0%———————-1.41%

5 years to 6 years—————-7.5%———————-0.91%

6.5 years to 8 years————–8.0%———————-0.41%

8 years & 7 months————–8.4%———————-nil

4. Loan facility is also available against KVP by pledging it with the bank.

Comparison with PPF & NSC:
No doubt PPF, NSC, Tax-saving bank FDs have an edge over KVPs due to associated tax benefits. But once you exhaust your section 80C limit & PPF investment limit, investing in KVP becomes an attractive proposition.

KVP vs. PPF
PPF maintains its superiority over all other small-saving schemes (even ignoring the section 80C tax benefit) because the post-tax yield of PPF is substantially higher than all other debt instruments. PPF is the only debt instrument (other than the EPF), where your interest income is completely exempt. Accordingly the tax-free interest of 8% from PPF is much better than 8.41% taxable interest from KVP. However, if your total income is either nil or less than basic exemption limit, then KVP will score over PPF.

Even after implementation of Direct Tax Code (DTC) which will make the PPF withdrawals taxable, post-tax returns of PPF will be better than KVP.

KVP vs. NSC

Now, let’s come to KVP vs. NSC. Isn’t NSC a better debt instrument than KVP (even after ignoring section 80C tax benefit on the amount invested in NSC)? …Let’s see

1. Returns: Yield is 8.40% from KVP as against 8.16% from NSC.

2. Taxation: First, NSC is one of the eligible instrument u/s 80C i.e., the amount of your income invested in NSC gets exempted from tax. Second, returns of both the instruments are chargeable to tax. But unlike KVP, NSC interest is again eligible for deduction u/s 80C. But if your section 80C limit is already exhausted, then this tax benefit offered on NSC is of no good.

In short, considering tax benefits NSC is undoubtedly better than KVP (Note: there won’t be any more tax benefit on NSC after implementation of DTC). However, if tax is not the criteria, then KVP returns are a little better than NSC and with a longer investment period of about 2.5 years.

Comparison with other Debt Instruments:

Over the last year, returns offered on bank FDs are steadily coming down. At present 5- to 10-yr bank FDs are offering interest in the range of 7.25% to 7.75%.

The YTM of non-convertible debentures is also coming down. The following is the maximum YTM of NCDs issues during last one year

TATA Capital NCD ————–>12%
Shriram Transport NCD———>11.50%
L&T Finance NCD (1st issue)—>10.50%
L&T Finance NCD (2nd Issue)–>8.58%

Although the YTM of 8.58% (accompanied with interest rate risk) on the L&T finance NCD 2nd issue in February 2010 was almost at par with KVP, the duration was 3 years as against almost 9 years of KVP.

Coming to medium and long term debt mutual funds, the 5-Yr category average returns are somewhere between (As on March 2010) 6 and 7 percent with some tax benefit due to tax arbitrage. Moreover, when there are chances of increasing interest rates, it is very risky to invest in long term debt funds.

So, due to above reasons, KVPs have started looking very attractive debt instrument offering relatively better returns without any risk.

Conclusion:

In a nutshell, if you’ve completed your tax savings and are looking for a debt instrument offering assured good returns combined with safety and liquidity then KVP is a good choice.

In other words, invest in KVP if you’re done with your tax saving investments and further exhausted your PPF investment limit (including your spouse & children) but make up your mind that you’ll remain invested till the maturity because if you make a premature exit, your effective yield will be considerably lower (the facility of making an early exit can be exercised in an emergency by sacrificing some returns).
 

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