Inflation indexed bonds: Hit ya miss?

Fri, 10 May Pre-Open

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Inflation indexed bonds (IIBs) are going to be launched soon. Sometime this month, it is reported. The Reserve Bank of India and the Finance Ministry are working on finalising the structure of such instruments. In addition, the tax treatments are also believed to be discussed. The ministry is planning to hold an auction for institutional investors to help determine the coupon rate.

All these efforts to ensure higher levels of retail participation...

Why retail participation? In this year's Union Budget, the Finance Minister had announced the launch of such an instrument as a way to deter investors from buying gold. The latter - as you would already know - is an asset class that investors turn to in order to protect themselves against inflation. And given that the yellow metal has been in favour over the past few years, it has been taking a toll on the country's current account deficit (CAD). As such, the broader efforts are towards curbing the CAD levels.

While the government may be expecting strong participation from the retail segment, it does raise one question - will it be easy to break the mindsets of people? We don't think so. It take some time for investors to put their money into something that is new to them and leaving aside a physical asset like gold. Also, apart from creating the demand for such instruments, the government will be required to educate people about the same. The bond market in India is still at its nascent stage, wherein the involvement of retail participants has been minimal. As such, one could only expect the demand for such bonds to come in over the medium to long term, as and when awareness is created.

Is the government targeting a very small segment?

The Business Standard recently reportedly that out of 100% of the gold demand in India 80% is consumed in the form of jewellery. Of the balance, three-fourths is in the form of investments including ETFs and the balance for industrial use. These data points are as per the World Gold Council and GFMS. Essentially, it does seem that these bonds are largely targeted towards the 15% of the gold consumption i.e. towards the investors in such an asset class.

WPI chosen over CPI...

It is also reported that the IIBs will be indexed with the wholesale price index (WPI) and not the consumer price index (CPI). As we all are aware, CPI is the one that is much higher as compared to the WPI. And since it measures the changes in the price levels of consumer goods and services purchased by households, benchmarking the bonds to the CPI would make more sense, especially for getting more retail participation.

While we believe that investors are more likely to hold on to gold, the success of such instruments can only be gauged in the future after giving consideration to factors such as tax benefits in addition to what is discussed above.