Many of you may be aware, "Inflation Indexed Bonds (IIBs)" will be launched on June 4, 2013 with first tranche of Rs 1,000 - 2,000 crore with a maturity of 10 years. The intention behind the launch of IIB is help provide real returns to investors and reduce physical gold buying spree. Whether it can indeed reduce gold imports would be discussed a little later, but first let's get to know IIBs a little better.
Meaning of IIBs:
IIBs are debt instruments which endeavour to offer return higher than the inflation rate (or to simply put, the rising cost of living which eats into our hard earned savings) if held till maturity. These bonds adjust the principal amount which one invests to the inflation, so that investors earn higher interest.
So, how would they be structured...
The IIB will be linked to the Wholesale Price Index (WPI) inflation with four months of lag, wherein the index ratio would be calculated thereby adjusting the principal amount invested with WPI inflation.
Meaning of IIBs:
IIBs are debt instruments which endeavour to offer return higher than the inflation rate (or to simply put, the rising cost of living which eats into our hard earned savings) if held till maturity. These bonds adjust the principal amount which one invests to the inflation, so that investors earn higher interest.
So, how would they be structured...
The IIB will be linked to the Wholesale Price Index (WPI) inflation with four months of lag, wherein the index ratio would be calculated thereby adjusting the principal amount invested with WPI inflation.
| Index ratio = |
| WPI inflation on adjustment date |
| WPI inflation on issue date |
Further, the aforesaid index ratio would be multiplied to the principal amount along with the coupon payment, to obtain the inflation-adjusted interest.
| Inflation-adjusted interest = (index ratio x principal amt.) x coupon rate |
So at maturity, you as an investor would get back the inflation-adjusted principal or face value, whichever is higher.
When can IIBs work for you?
You see in an inflationary scenario, where prices are on a rise and have an effect of eroding the value of hard earned savings, IIBs can work well for you. But during deflationary phase, they may not yield you much luring returns since them being linked to WPI inflation.
In the current scenario can they provide luring returns?
Well the launch of IIBs has come in at a time where WPI inflation has depicted a descending trend and moderation in the last few months. Thus one may not get attractive annual yields immediately. However if WPI inflation continues to haunt once again as the economic growth starts picking up, IIBs could yield better annual yields.
But PersonalFN is of the view that, instead of using WPI inflation for indexing, the Consumer Price Index (CPI) inflation should have been used as it is more relevant to citizens who are saddled with rising cost of living. You see, there's yet a huge gap between WPI inflation and CPI Inflation which reflects what consumers are paying. April 2013 CPI inflation at 9.39% is higher than 4.89% WPI inflation for the same month.
Having said that, it appears Reserve Bank of India (RBI) has plans to move to CPI inflation once it stabilizes, as per the statement of Mr R. Gandhi, Executive Director of RBI. "Once the CPI stabilizes, we may move over to that index," he said.
As far as the tax status is concerned, thus far special tax status hasn't been provided to IIBs. So, there doesn't appear an incentive for retail investors to invest; but having said that, investors can claim capital indexation benefit.
So, would IIBs divert attention of investors from gold and fixed deposits?
PersonalFN is of the view that while the Government intends to restrain India's insatiable appetite to own precious yellow metal which has put pressure on Current Account Deficit (CAD); it appears unlikely that investors' attention would be diverted from gold, at least until economic uncertainty persists. In fact drop in price of gold would attract many to buy more for both emotional and financial reasons which may keep exerting pressure on country's CAD. So while the objective of IIBs as per the central bank is to protect savings of poor and middle classes from inflation and incentivize household sector to save in financial instruments rather than buying gold, it may not appeal many investors. Likewise,risk averse investors may continue to invest in one of their most popular investment avenue i.e. Fixed Deposits (FDs), although they may not very tax-efficient and / or provide inflation-adjusted returns. Thus the complex structure of these bonds may desist many and may also find it difficult to compete with other debt instruments.
You see in an inflationary scenario, where prices are on a rise and have an effect of eroding the value of hard earned savings, IIBs can work well for you. But during deflationary phase, they may not yield you much luring returns since them being linked to WPI inflation.
In the current scenario can they provide luring returns?
Well the launch of IIBs has come in at a time where WPI inflation has depicted a descending trend and moderation in the last few months. Thus one may not get attractive annual yields immediately. However if WPI inflation continues to haunt once again as the economic growth starts picking up, IIBs could yield better annual yields.
But PersonalFN is of the view that, instead of using WPI inflation for indexing, the Consumer Price Index (CPI) inflation should have been used as it is more relevant to citizens who are saddled with rising cost of living. You see, there's yet a huge gap between WPI inflation and CPI Inflation which reflects what consumers are paying. April 2013 CPI inflation at 9.39% is higher than 4.89% WPI inflation for the same month.
Having said that, it appears Reserve Bank of India (RBI) has plans to move to CPI inflation once it stabilizes, as per the statement of Mr R. Gandhi, Executive Director of RBI. "Once the CPI stabilizes, we may move over to that index," he said.
As far as the tax status is concerned, thus far special tax status hasn't been provided to IIBs. So, there doesn't appear an incentive for retail investors to invest; but having said that, investors can claim capital indexation benefit.
So, would IIBs divert attention of investors from gold and fixed deposits?
PersonalFN is of the view that while the Government intends to restrain India's insatiable appetite to own precious yellow metal which has put pressure on Current Account Deficit (CAD); it appears unlikely that investors' attention would be diverted from gold, at least until economic uncertainty persists. In fact drop in price of gold would attract many to buy more for both emotional and financial reasons which may keep exerting pressure on country's CAD. So while the objective of IIBs as per the central bank is to protect savings of poor and middle classes from inflation and incentivize household sector to save in financial instruments rather than buying gold, it may not appeal many investors. Likewise,risk averse investors may continue to invest in one of their most popular investment avenue i.e. Fixed Deposits (FDs), although they may not very tax-efficient and / or provide inflation-adjusted returns. Thus the complex structure of these bonds may desist many and may also find it difficult to compete with other debt instruments.
PersonalFN
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