Tax-Free Bonds in India: The 8.5% Coupon That Doesn't Actually Pay You 8.5%

Picture the moment an investor scrolls past a bond listed at an 8.5% coupon, tax-free, government-backed. On paper, that's an extraordinary number for someone in the 30% tax bracket; an 8.5% tax-free yield is the equivalent of finding a taxable instrument paying over 12%. Few conventional fixed-income investments appear as attractive at first glance. They buy it, satisfied, assuming that 8.5% is exactly what they've locked in.

It isn't. Not even close, in many cases.

Here's what actually happened: that bond was issued back when interest rates were meaningfully higher than they are now, and it hasn't been reissued since because the government stopped issuing tax-free bonds altogether after 2016. Everyone buying one today is buying it secondhand, on the stock exchange, from another investor. And because an 8.5% fixed coupon looks incredible next to today's rates, the market has bid its price up well above its ₹1,000 face value sometimes to ₹1,250, ₹1,300, or more. The coupon on the label and the return you actually earn on the price you paid are two completely different numbers, and the gap between them is exactly where a lot of retail investors get quietly disappointed a few years into holding one of these bonds.

This is the article that exists to close that gap a genuine, complete look at what tax-free bonds are, who issues them, what a "full list" of them actually looks like in a market where nothing new has been issued in nearly a decade, and most importantly how to read the return you'll actually get, not the one printed on the bond's name.

Quick Answer

Tax-free bonds are long-tenure debt instruments issued by government-backed entities like NHAI, PFC, REC, IRFC, HUDCO, and NABARD, where the interest is fully exempt from income tax under Section 10(15)(iv)(h) of the Income Tax Act. No new tax-free bonds have been issued since 2016, so every purchase today happens on the secondary market (NSE/BSE), typically at a premium to face value meaning the bond's actual Yield to Maturity (YTM) is usually meaningfully lower than its printed coupon rate. Current YTMs on tax-free bonds generally range from roughly 4.5% to 6.5%, which sounds unremarkable until you calculate the tax-equivalent yield: for an investor in the 30% tax bracket, even a modest 5.5% tax-free yield is equivalent to a 7.86% taxable return. These bonds suit investors in higher tax brackets seeking predictable, long-term, tax-exempt income, not investors chasing the highest headline coupon they can find.

Unlike fixed deposits, tax-free bonds trade on the stock exchange, so their market prices fluctuate daily before maturity which is exactly why the coupon rate alone can be misleading, and why the rest of this guide leans so heavily on YTM instead.

What Are Tax-Free Bonds?

Tax-free bonds are long-term debt securities issued by specified government-backed public sector undertakings (PSUs), where the interest earned is exempt from income tax under Section 10(15)(iv)(h) of the Income Tax Act. They were issued in tranches between roughly 2012 and 2016 to fund infrastructure, housing, and power-sector projects, and are now bought and sold exclusively on the secondary market through NSE and BSE, since no new tax-free bonds have been issued since.

Why a "Full List" Is Trickier Than It Sounds

Most articles that promise a "full list of tax-free bonds" quietly skip past the most important fact about this category: the list stopped growing in 2016.

The Government of India used tax-free bonds as a borrowing tool for a specific window largely between 2012 and early 2016 to fund infrastructure-focused PSUs without adding directly to sovereign taxable debt. Since then, the government has shifted toward other borrowing instruments, and no fresh tax-free bond issuance has taken place. The government gradually shifted its borrowing towards other instruments, reducing the need for fresh tax-free bond issuances by public sector entities. Every tax-free bond available to you today is a legacy instrument, originally issued years ago, now trading between investors on the secondary market rather than being sold fresh by the issuer.

This changes what a genuinely useful "list" needs to show you. It's less useful to list exact prices (which shift daily and would be stale within a week of publishing) and far more useful to understand which issuers exist, how to read what you're being offered, and how to translate a quoted number into what you'll actually earn which is exactly what the rest of this guide is built to do.

If you're weighing tax-free bonds against other parts of the fixed-income shelf, it's worth understanding how they differ from Government Bonds, Corporate Bonds, and plain Fixed Deposits each solves a different problem, and tax-free bonds are really a tax-optimisation play layered on top of the same underlying credit-risk questions those comparisons already cover.

The Major Issuers You'll Actually Encounter

Because these are all legacy PSU issuances, the universe of issuers is well-established and hasn't changed in years. Here's the landscape:

Many of these issuances have historically carried AAA ratings from agencies like CRISIL and CARE, reflecting government ownership and the historically low default probability of this category. That safety profile is genuinely one of the stronger arguments for the category but as covered in most credit-risk discussions, a rating reflects probability, not a guarantee, so investors should always check the current rating of the specific bond series before investing rather than assuming the original issuance-year rating still applies unchanged. It's also worth checking whether a specific series carries a call option, since early redemption by the issuer can affect the total return you ultimately receive.

The Coupon Trap, Explained Properly

This is the single most important mechanic to understand before buying any tax-free bond, so it's worth walking through slowly.

When these bonds were issued between 2012 and 2016, prevailing interest rates were considerably higher than they are in mid-2026. A bond issued back then at, say, an 8.5% fixed coupon was competitive with the market conditions of its time. Interest rates have since moved lower, which means that the same 8.5% fixed coupon now looks exceptional relative to what's currently available and exceptional fixed coupons attract buyers, which pushes the bond's secondary market price up above its ₹1,000 face value.

Here's the part that trips people up: the coupon rate never changes, but the price you pay does and your actual return is calculated on the price you paid, not on the face value. The coupon is fixed forever. Your return isn't.

A concrete example. Say a tax-free bond has an 8.5% coupon on a ₹1,000 face value meaning it pays a fixed ₹85 per year regardless of what you paid for it. If you buy that bond at face value (₹1,000), your yield is genuinely close to 8.5%. But if the secondary market has bid the price up to ₹1,300 because everyone wants that fixed coupon, your actual Yield to Maturity is meaningfully lower because you're now measuring that same fixed ₹85 annual payout against a larger amount of capital, and you'll also take a capital loss of ₹300 when the bond redeems at its ₹1,000 face value on maturity.

This is exactly why Yield to Maturity (YTM), not the printed coupon, is the number that actually matters. YTM accounts for the price you're paying today, the fixed coupon you'll receive, and the capital gain or loss you'll realise at maturity when the bond redeems at face value collapsing all of it into a single, honest annual return figure. Any bond platform worth using will show you the YTM prominently often alongside a built-in tax-free bond calculator that converts price, coupon, and remaining tenure into a live YTM figure automatically and if a listing only shows the coupon rate without a clear YTM figure, that's worth treating as an incomplete picture rather than a mistake to work around yourself.

One more detail worth knowing: when buying a tax-free bond in the secondary market, you may also pay accrued interest to the seller, depending on the settlement date relative to the bond's coupon dates. This isn't an additional cost or a hidden fee it's simply compensation for the portion of interest the seller earned during their holding period before the sale, and you'll recover the equivalent when you receive your own next full coupon payment.

What You're Actually Earning: The Tax-Equivalent Yield

Once you're looking at YTM instead of the printed coupon, the next step is translating that YTM into something comparable to your other options because a 5.5% tax-free YTM and a 5.5% taxable FD rate are not remotely the same return.

The formula is simple:

Tax-Equivalent Yield = Tax-Free Yield ÷ (1 − Your Tax Rate)

Read that table the way it's meant to be read: if you're in the 30% bracket and a tax-free bond is offering a 5.5% YTM, you'd need a taxable bond paying close to 7.86% just to match it after tax and as covered in most corporate bond comparisons, even a solid AAA-rated corporate bond typically isn't offering that much of a premium over the risk-free rate. This is the entire investment case for tax-free bonds in one table: the headline yield looks unremarkable, and the tax-adjusted reality is what actually makes the category worth considering.

This comparison assumes you hold the bond to maturity and focuses only on annual interest income, not capital gains or losses from buying above or below face value; those are a separate calculation, covered in the risks section below, and worth factoring in separately before you commit.

Who Should Actually Consider These Bonds

Strong fit:

• Investors in the 20% or 30% tax bracket, where the tax-equivalent yield genuinely competes with or beats taxable alternatives
• Investors with a long, defined time horizon who don't need the capital back before the bond's remaining maturity (roughly 2028–2031 for most currently available series)
• Investors prioritising predictable, high-credit-quality PSU-backed annual income over growth or flexibility retirees and conservative long-term savers are the classic profile here

Weaker fit:

• Investors in lower tax brackets, where the tax exemption doesn't meaningfully outperform a straightforward FD or G-Sec
• Investors who might need to exit early tax-free bonds can have thinner secondary market liquidity than G-Secs, and selling before maturity exposes you to both price risk and capital gains tax on any profit
• Investors expecting reinvestment flexibility since no new tax-free bonds are being issued, there's nowhere to "roll" this allocation into once it matures; you'll need a different instrument for that capital afterward

The Risks Worth Knowing Before You Buy

Interest-rate risk. Like any long-tenure fixed-coupon bond, the market price of a tax-free bond moves opposite to interest rates. If rates rise after you buy, the resale value of your bond can fall irrelevant if you hold to maturity, very relevant if you need to exit early. Longer-maturity bonds generally experience larger price movements than bonds closer to maturity, so a series maturing in 2031 will typically be more sensitive to rate changes than one maturing in 2028.

Liquidity risk. These bonds are listed and tradeable, but trading volumes are generally thinner than G-Secs and can vary significantly by issuer and series. Sticking to bonds from the larger, more actively traded issuers NHAI, PFC, IRFC tends to offer better liquidity than smaller or less-followed series.

Reinvestment risk at maturity. Because no new issuances exist, when your tax-free bond matures and returns your principal, you can't simply buy a fresh one to replace it. That capital will need a new home in whatever tax-free-adjacent or tax-efficient alternative exists at that time.

Capital gains taxation on early exit. The tax exemption applies specifically to the interest income not to any profit from selling the bond before maturity. If you sell at a price above what you paid, that gain is taxable: as a long-term capital gain (currently 12.5% on listed bonds held over 12 months) or a short-term gain at your slab rate if held for 12 months or less.

Inflation risk. Since the coupon is fixed for the life of the bond, rising inflation over a long holding period can erode the real purchasing power of your annual interest income, even though the rupee amount you receive never changes.