In a bid to prop up the flagging economy the government has decided to allow state-owned undertakings to issue tax-free bonds in the first half of the financial year. This should be good news for investors since 70% of these bonds are reserved for public issuance and out of this of this, 40% will be for reserved for retail investors.

These bonds will be benchmarked to the 10-year Government Security, which is currently trading close to 9%. This makes the tax-free bonds a good option since the yields on these bonds too will increase. And these will be issued for long term, of 10-20 years.

Ashish Shanker, Head-Investment Advisory, Motilal Oswal Private Wealth Management says that investors should definitely consider these tax free bonds since they will offer competitive yields.

But since these are long-term bonds, the rating becomes very important.

In the current environment investors should be very concerned with the rating, because a 10-year period is very long. There have been cases where over long periods even the best rated instruments have been downgraded, says Sumeet Vaid, of Ffreedom Financial Planners. His advice is to avoid papers which are rated below AAA.

However, according to Raghvendra Nath, Managing Director Ladderup Wealth Management since these are quasi-government bonds they are safe to invest in. And with G-Sec yields at an all time high, if any company issues comes out with the bond issue now, investors can look forward to high yields. Since the G-Sec is at around 9%, the yield on tax-free bonds, if issued now, could be around 8.5%, Nath says.

Some of the public undertakings that will be raising funds are IIFC, IRFC, PFC, NHAI, Hudco, REC, NTPC, NHPC, Indian Renewable Energy Development Agency, Airports Authority of India and Cochin Shipyard. Together these entities are looking to raise Rs 48,000 crore.

With interest rates mostly seen lower in next few years, locking funds for long term in tax free bonds is a good avenue, says Kiran Kavikondala, Director, WealthRays Group.

These are advisable for only for long-term investors and those looking for regular income as most of the bonds allow payment of interest on an annual basis, he says.

These bonds are better suited for investors in the higher tax bracket, 20% of above, as the yields fetch around 10.5% pre-tax. For those in the 10% tax bracket, corporate fixed deposits with high credit ratings are a better options since the return from the tax free bonds would be around 8.5%, while the corporate FD would give 10-10.5%, Kavikondala says.

A healthy secondary market is another factor to consider before investing. Since these are long term bonds there should be a chance to exit, if required, Vaid says.

Since most of the bonds are allowed to be held in demat form, investors with demat accounts should consider this option. This will also make it easier for investors to sell in the secondary market, since these bonds are generally listed on the stock exchanges, says Kavikondala.

Investors should also check if any of the bonds have the call or put options, whereby the issuing company can call back bonds for redemption or investor can redeem at an early stage, he adds.