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New inflation-linked bonds good bet

india Updated: Dec 01, 2013 23:28 IST
Reserve Bank of India

The Reserve Bank of India (RBI) has inched closer to fulfilling the promise that new governor Raghuram Rajan made in his first statement two months ago, bringing savers one step close to having access to what looks like the best deposit that they will be able to find.

The central bank has announced details of a deposit whose interest rate is linked to the consumer inflation in India. The bank has said that this new instrument, called the inflation indexed national savings securities (IINSS), will offer an interest rate of 1.5% per annum (paid every six months), while the principal amount — on which the interest is paid — will keep rising up every month in step with inflation.

IINSS is meant for retail investors, with a limit of `5 lakh per applicant. According to the RBI, the IINSS will be based on the ‘final combined CPI’ with a three-month lag. For example, the provisional combined (meaning rural and urban) inflation rate was 10.09% per annum. If the final rate is also the same, then in January — which is a three-month lag from October, the principal amount of `10,000 invested in IINSS will rise to `10,080.47. This is an increase of 0.08047%, which is compounded over 12 months.

If the inflation rate were to sustain at this level, then after one year the saver would have total gains of 11.5%. This high return, with a government guarantee, sounds phenomenal and it is. However, the real icing on the cake is the tax-efficiency of these deposits. As the RBI’s statement makes clear, the inflation-adjustment of the principal is capital gains. On adjustment with the cost-inflation index, they will essentially disappear and thus be effectively tax-free. Only the 1.5% of interest income will be taxable.

IINSS could be the first choice of any smart saver. But, there could be a catch. I would not too surprised if the tax authorities bowl a googly.