RBI announces Scheme for Inflation Indexed Bonds – 2013-14 – A Reality check to tame inflation

Will this become the new favorite for all financial planners and wealth advisors to fight inflation? Will this replace the normal corporate bonds or fixed deposits in retail portfolio? Will this be the new home for risk averse investors?

For Rs. 12,000-15,000 crore

– To be issued in tranches

– First tranche on June 4, 2013 for Rs. 1000-2000 crore

Pursuant to the announcement made in the Union Budget for 2013-14 to introduce instruments that will protect savings of poor and middle classes from inflation and incentivise household sector to save in financial instruments rather than buy gold, RBI, in consultation with Government of India, has decided to launch Inflation Indexed Bonds (IIBs).

2. For appropriate price discovery and market development, it is however, necessary to issue comparable instruments through auctions to the institutional investors such as Pension Funds, Insurance, and Mutual Funds etc. This will create demand for IIBs and help in making them tradable in the secondary market. It is therefore proposed to issue initial series for all categories of investors including institutional investors and, later, another series, exclusively for retail investors. First series of IIBs would be issued in first half of the current financial year. To target greater retail participation for this series also, it has been decided to enhance the non-competitive segment for retail and mid-segment investors to 20 per cent from the present level of 5 per cent applicable to auction of usual GoI securities.

3. The details for first series of IIBs are as under:

  • IIBs will be having a fixed real coupon rate and a nominal principal value that is adjusted against inflation. Periodic coupon payments are paid on adjusted principal. Thus these bonds provide inflation protection to both principal and coupon payment. At maturity, the adjusted principal or the face value, whichever is higher, will be paid.
  • Index ratio (IR) will be computed by dividing reference index for the settlement date by reference index for issue date (i.e., IR set date = Ref. Inflation Index Set Date / Ref Inflation Index Issue Date).
  • Final Wholesale Price Inflation (WPI) will be used for providing inflation protection in this product. In case of revision in the base year for WPI series, base splicing method would be used to construct a consistent series for indexation.
  • Indexation Lag: Final WPI with four months lag will be used, i.e. Sept 2012 and Oct 2012 final WPI will be used as reference WPI for 1st Feb 2013 and 1st March 2013, respectively. The reference WPI for dates between 1st Feb and 1st March 2013 will be computed through interpolation.
  • Issuance method: These bonds will be issued by auction method.
  • Retail Participation: Non-competitive portion will be increased from extant 5 per cent to up to 20 per cent of the notified amount in order to encourage participation of retail and other eligible investors.
  • Maturity: Issuance would target various points of the maturity curve in order to have benchmarks. To begin with, these bonds will be issued for tenor of 10 years.
  • Issuance Size: Each tranche of IIBs will be for `1,000 – 2000 crore and total issuance would be for about `12,000-15,000 crore in 2013-14.
  • Issuance Date: First such tranche will be issued on June 4th 2013 and the same would be issued regularly through auctions on the last Tuesday of each subsequent month during 2013-14.

4. Second series of IIBs exclusively for retail investors will be issued in second half of the financial year. First series of the IIBs will help in determining the coupon rate for the bonds through auction. This will help in benchmarking IIBs. Based on the experience in the initial issuances, second series of IIBs for the retail investors is proposed to be issued around October. Terms of issuance of IIBs for retail investors would be announced in due course

Biharilal Deora, CFA, ACA


One Response

  1. Hi,

    The main rationale for introducing inflation indexed bonds in last budget was to induce private savings awwy from unproductive assets like gold and real estate, which was hurting India’s current account balance severly. Now, with the introduction of indexed bonds with the WPI as inflation measure, I am sure retail investors are not likely to shift their savings to these bonds as the there is a vast difference between CPI and WPI; and CPI is what retail investors are concerned with. These indexed bonds will have more demand from institutional investors and banks.

    Shiv Desai, CFA

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