The Reserve Bank of India on Thursday came out with a technical paper on issuing inflation-indexed bonds (IIB) that aim to provide a cover to the debt investment against inflation. A look at what it is, what it means and who should invest.
What is an inflation-indexed bond?
When inflation hits double-digit figure, it is often reported that the real return on fixed deposits have turned negative. The IIBs are bonds that offer to provide protection from inflation to both the interest payment and the principal by linking them to the wholesale price index and are thus designed to cut out the inflation risk of an investment.
How does it work?
If you are issued an IIB at a face value of Rs 100 with a real coupon rate of 8% and the inflation index goes up by 10%, then the principal for calculating the coupon payout will become R110 and the coupon payment will stand at Rs 8.80.
What benefits does it offer?
Investors can safeguard their risk of inflation and use it as a risk diversification tool. It will also offer cost savings for the government on account of reduction in coupon payments with lowering inflation rate, elimination of uncertainty risk premium.
Who should buy?
Experts say that this product was needed and long-term fixed deposit investors should have some exposure into these bonds as it is risk free debt asset post inflation. However, considering the fact that the product may have a lock-in of a longer period, experts’ say that senior citizens may not get into it. Also only part of the investible debt asset that can be locked should be invested.
How will it be issued and what will be the tenure of the bond?
The technical paper has proposed that IIBs may be issued through auction method, a practice similar to the fixed rate bond issues and has proposed to issue IIBs of 10/12 years as the instrument will have more demand in this bucket.