Gentlemen Prefer Inflation Indexed Bonds

Instead of WPI-linked bonds, Indian households would rather have CPI-linked  securities shield them from inflation

For the first time, the RBI is set to issue inflation-indexed bonds (IIBs). These will debut on 4 June with this grand objective: ‘To protect savings of the poor and middle classes from inflation.’ By definition, such bonds pay their holders an interest rate over and above inflation. The big idea is to win household savings back to financial instruments, money that has been going into gold as an assumed hedge against the rupee’s falling purchasing power. “In principle, it is a very sensible move, as the mechanism protects both the principal and coupon rate from the corrosive effect of inflation,” says Deepak Kapoor, a financial consultant with ADC Legal Services Pvt Ltd.

About Rs 15,000 crore worth of IIBs are slated for issue this financial year. Though aimed at household savers, institutional investors are expected to participate in June’s auction, and this demand will determine their coupon rate.

While sensible, the move is being dubbed a half-measure, as the inflation against which people’s savings would be protected is India’s wholesale rate, the WPI, which usually understates the true cost of living in India. “Linking IIBs with the WPI is more of a political statement by the Government on having ‘tamed’ inflation,” says Professor CS Balasubramaniam of Babasaheb Gawde Institute of Management Studies. In reality, it is always the Consumer Price Index (CPI) that reflects household expenses. In the West, such bonds are usually linked to this index. In India, this difference is significant at this juncture because of a wide gap—of more than 4 percentage points—between the official measures of wholesale and retail inflation. Critics say that India’s WPI-linked IIBs will not save a household its inflationary losses.

However, others argue that WPI-linked IIBs are the best the country can offer at this point, given that using the CPI would push the Centre’s overall borrowing costs up and worsen its already-burdened finances. Still, the Centre is said to be considering CPI-linked bonds as well.

Another worry is that aam households may not have the cash surpluses needed to invest in IIBs, and so only the financially savvy will buy them. Retail investors may also be put off by the tax they may need to pay on the returns of these bonds. “Some tax incentives should be provided,” says Kapoor. Yet, for all their weaknesses, he adds, IIBs could help India’s bond market get past its infancy phase. At least they are a safe option for the aam aadmi. Unlike chit funds.

About The Author

Shailendra Tyagi