Inflation Indexed Bonds – solution or false hope?

Having failed badly in the Indian market over a decade and a half ago, a second attempt to launch Inflation Indexed Bonds has raised hopes of protecting investors but cynics question about the false hopes that have been raised by the hype around the new bonds floated.

The economy has been battling high inflation for some time now (although Wholesale Price Index has lately cooled down to 4.89%) and many are expecting some relief in the IIBs that hit the market in June.

Are IIBs a real solution or just hype?

The Reserve Bank of India (RBI) is all set to sell Rs 10 to Rs 20 billion of bonds to interested foreign and domestic investors in the first phase. The main motive behind the release of IIBs is to wean away investors from physical gold that has been causing the Current Account Deficit to rise dangerously.

The principal amount of IIBs is based on current inflation in the economy and adjusted by an “inflation indexation factor” for every interest payment period.

Unlike 1997 when IIB had miserably failed, this time principal amount of the bonds is linked with WPI and is also linked to coupon rates (interest on bonds) that would be revised every quarter.

IIB – best bet against inflation but some questions still need answers

WPI numbers have been in the comfort zone for quiet sometime now however, the Consumer Price Index (CPI) is high at around 9.39%, still way acceptable levels for any economy. Headline retail inflation too soaring above the comfort level and the spread between CPI and WPI is ever increasing.

Then what is the rationale for picking WPI and not CPI for IIB linkage?

In the present scenario IIBs would only work on the basis of WPI and gauge inflation only on this consideration completely ignoring CPI. Most economists feel CPI is more inclusive and there is every chance that these much publicized sovereign bonds might miss out on exact level of luring returns. bonds

To top it RBI and the government have gone to town claiming that IIBs are a natural hedge against inflation and could help to curb gold purchase in the country.

It needed to be remembers that majority of gold purchased is in jewellery form. Much of it is bought for status collection and only few venture to buy it for investment purposes and majority of the investment that is made into gold in physical form is through black money sourced from illegal routes in the absence of strict check.

The proportion of investment directed towards Exchange Traded Funds (ETFs) and other forms of paper gold constitutes only around 10% – 15% of the total purchase in the market. Therefore, more likely that only these limited set of investors (who only invest for high returns) would turn over to IIBs.

Knowledge about IIBs is abysmally low among majority of the investors who buy considerable amount of gold in the country.

These sovereign bonds need to be find acceptance in order to curb the gold purchase and improve the alarming CAD figures at the earliest.

A mechanical engineering graduate with a post graduation in marketing and sales, Ashish has combined professional experience of more than 4 years. Ashish is a great fan of Martin Scorsese. He loves to write poetry in his spare time. He lives in Shimla.

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1 Comment

  1. says: Sridhar

    It is a con-job by Govt. You see after people said they would come out with these bonds, immediately the inflation is now dropped by over 35-40% … they will “fix”the inflation reporting and pay less….

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