Inflation Index Bonds
Inflation Index Bonds (IIBs) are an enhanced version of Capital Indexed Bonds (CIBs) that were issued during 1997. While CIBs provided protection against inflation only for the principal amount, IIBs provide protection for the interest as well. The salient features of IIBs are as follows:
IIBs have a fixed real coupon rate, but a nominal principal value that is adjusted against inflation. Periodic coupon payments will be made on the adjusted principal. In this way, these bonds will provide inflation protection to both principal and coupon payment. When the bond matures, the higher of adjusted principal or face value will be paid.
Final Wholesale Price Index (WPI) is being used for providing inflation protection. In case of revision in the base year for WPI series, base splicing method would be used to construct a consistent series for indexation.
- These bonds are being issued by auction method. After the initial auction, they are traded in the secondary market.
- Non competitive portion will be increased from 5 percent to up to 20 percent to encourage retail participation.
- To begin with, these bonds are being issued for a tenor of 10 years.
The basic purpose for releasing IIBs is to protect the savings of poor and middle class from inflation. Another reason was to provide incentives to the household sector to save in financial instruments rather than in gold. The increasing Current Account Deficit (CAD) driven by higher gold imports was becoming a cause of serious concern.
Since the investment in IIBs can take care of the prevailing inflation, the retail investment will be benefited. This is because they help the small investor to safeguard even the principal amount against inflation, apart from receiving the yield of the investment, based on the prevailing inflation. Since the gold prices have been volatile and the small investor cannot accumulate enough capital to invest in real estate, it is expected that IIBs would prove to be beneficial for the investor. It is also expected to boost the domestic savings and reverse the decline in savings-to-GDP ratio.
However, the purpose of issuing these bonds will be fulfilled only if they are available largely to retail investors, rather than big pension funds or insurance companies. Linking them with the CPI rather than WPI, in the future, would be another step in the right direction.
