Zero-coupon debentures may become more popular as debenture issuers and fixed-income mutual funds seek ways to reduce the impact from the 15% withholding tax imposed on gains from fixed-income mutual funds.
Mutual funds were not defined as a taxable unit for many decades, with investors in mutual funds reaping gains from the 15% tax privilege. But a change occurred when the cabinet in August 2018 approved the 15% withholding tax on gains from fixed-income funds.
The tax tweak is meant to reduce inequality in taxation between direct investment in debt securities and investment in debt securities through mutual funds.
The change has been in effect since Aug 20, 2019.
Ariya Tiranaprakit, senior executive vice-president of the Thai Bond Market Association (TBMA), said the credit spread, a gap between government bond yield and corporate bonds, on average has increased by 0.15% after the 15% withholding tax came into effect because mutual funds will have to generate higher returns to compensate for the imposed tax.
"We may see market participants adjust more. For example, debenture issuers may issue corporate bonds that do not pay interest such as zero-coupon bonds, and fixed-income mutual funds could launch feeder funds to invest in foreign debt instruments, which are not liable for the withholding tax," she said.
A zero-coupon bond is a debt security that does not pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value.
At present, mutual funds represent 93% of total short-term corporate bonds and make up 64% of daily trade of long-term corporate bonds, according to the TBMA.
There was an impact in fixed-income mutual funds traded on the secondary market between Aug 20 and Nov 15. The trading volume of debt securities in the secondary market declined substantially during that period.
The average daily trading value of fixed-income mutual funds decreased by 44% to 1 billion baht from 1.8 billion, while the trading value of long-term corporate bonds fell by 40% to 1.4 billion from 2.3 billion.
For the primary market where issuers sell bonds for the first time, there was a decline after the 15% withholding tax was imposed.
Daily short-term debenture issuance was valued at around 2 billion baht between Aug 20 and Nov 15, down from 3 billion per day previously.
Long-term debenture issuance also fell by 50% during the first two months after the tax measure became effective, said Ms Ariya.
"Luckily, a downward trend in global interest rates and a year-to-date decline in Thai government bond yield by 0.5-0.7% help offset the higher cost of credit spread. Debenture issuers still reap gains amid a decline in interest rates," she said.
Bond buyers in the primary market are mostly made up of high net worth investors seeking higher returns, said Ms Ariya.
On the contrary, mutual funds make up the majority of investors in the secondary market.
"The growth of the primary corporate bond market is driven by supply from private companies to raise funds for business expansion and that want to lock in low interest rates," she said.
The TBMA projects new corporate bond issuance will tally 800 billion baht in 2020.