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CA Bhavik Mehta

Inflation eats into your money and reduces its purchasing power. To tackle this, you need to invest in products that beat inflation. Inflation-indexed bonds, due to be floated later this month, may be one such option.

Inflation-indexed bonds for retail investors are all set to be launched in the second half of this month. According to the Reserve Bank of India (RBI), this product aims to protect savings from inflation, especially those of low- and middle-income groups. But does this product really do that, and should you go for it?  While the Inflation Indexed Bonds linked to Wholesale Price Index (WPI) has not seen a great response with participation mostly coming from insurance companies and pension funds, experts say that the proposed IINSS-C bonds (inflation bonds linked to the consumer price index) may also take a while to catch on. Although RBI has reserved 20 per cent of the WPI bonds for retail investors, the auctions has seen a very lackluster response from retail investors due to the fact that the Consumer Price Index (CPI) inflation is much higher than the WPI. The 1.44 per cent 2023 inflation indexed bonds that was first issued in June is currently trading around 3.63 per cent. In the last few auctions of the bond, there were no bids in the non-competitive segment reserved for retail investors.

The government has planned to raise Rs 12,000-15,000 crore in FY14 through inflation indexed bonds. The bonds would help correct the macroeconomic imbalances especially the high current account deficit caused by domestic investors widespread use of gold as an inflation hedge. Only crude oil accounts for a larger share of India’s imports than gold. India this year may import 900 to 1,000 metric tons of gold this year. The World Gold Council report says that India has imported about 560 tons of gold in the first six months of 2013.

According to Moody’s Credit Outlook June 10, 2013 issue, “If inflation indexed bonds reduce domestic investor demand for gold as an inflation-hedge asset and reduce gold imports, it would alleviate balance of payments and exchange rate pressures.”

However, any tempering in gold imports in the near term is more likely to come from the recently extended import curbs than from inflation-indexed, which will total Rs 150 billion (Rs 15,000 crore) this year, compared to our estimate of an Rs 3 trillion (Rs 3,00,000 crore) gold import bill,” added Moody’s.

We can evaluate a product on various parameters—tenor, rate and taxation. This bond is a 10-year product and is a cumulative interest product, which means it does not throw off any income. The maximum you can invest is Rs.5 lakh. The interesting thing about this bond is that it gives you a return of 1.50 percentage points over the Consumer Price Index (CPI). It aims to protect people against the inflation that really bites. Now, the third thing is taxation. So when the 10-year tenor is over and you get your money back at the current rates of inflation, then Rs.5 lakh would grow toRs.15 lakh. The current rate of inflation is 10%, which we think will fall. On the gains, you will pay tax as per your slab rates.

So, finally there is a bond that does what we wanted it to do: protect people against CPI. It is a great product for those who are fixed deposit (FD) investors because FDs give you negative rates of return when inflation is high. It works for those who are in the lowest tax bracket. At every inflation point it does better in terms of real rate of return.

But in some ways, it disappoints because this is a product that a retired person should ideally use for inflation indexing his retirement corpus. This means you need a product that will give regular income—if not quarterly or semi-annually, at least annually. Let’s assume that there is a person who ladders his investment—Rs.5 lakh now and Rs.5 lakh next year. But for a person who is retiring and needs a corpus of around Rs.1 crore, this bond is not working. In terms of annual return, Rs.5 lakh is too little. For a person in the 30% tax bracket, it is giving negative returns at every possible CPI level. But at each level, it’s better than FD. So these are the pros and cons.

If you are an FD investor, switch to this bond. If you are a smarter investor and have an asset allocation towards equity mutual funds or direct stocks, this is not a product for you because in 10 years you stand to do much better in well chosen equity products.

Lock in period:

One can withdraw in three years. For senior citizens, it is one year lock-in. But if you pull back after the third year, you lose half the interest of the previous year.

Variability in returns is seen as a key factor in CPI-linked inflation bonds by some financial advisors “While in a fixed income instrument your yield is locked, in an inflation-linked bonds, your returns are getting adjusted to inflation. These bonds can be looked at by pensioners or people with low risk taking appetite who would like to cover their expenses,”

Post-tax returns from CPI-linked inflation bonds may find it difficult to compete with post-tax returns from PPF if the consumer inflation falls or is at low levels.

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  1. naresh prasad sinha says:

    a good and analysis and well worded but confuses whether the retired people to invest or not. a practical example with net gain or otherwise could have solved the dilemma.

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May 2024