What are inflation-indexed bonds and why is RBI launching them now
In order to protect savings from inflation, reduce the physical holding of gold as the record import of the yellow metal widened the current account deficit to 6.7% of GDP in the final quarter of 2012, and incentivise households to save in financial instruments, RBI is launching the 10-year IIBs for R12,000-15,000 crore for 2013-14. The bonds, which will be issued in several tranches, will provide inflation protection to both principal and interest payments. The first tranche, which will be auctioned on June 4, will be for R1,000 crore and the initial series of the bonds will be for all categories.
How frequently will IIBs be issued
There will be regular issuance through auction on the last Tuesday of each month, including the last Tuesday of June. Later, according to RBI, in the second half of the current financial year, there will be another series exclusively for retail investors and the first series of IIBs will help in determining the coupon rate for the bonds through auction. While in the first half of the current financial year the re-issuances will be for 10-year, in the second half the central bank will decide whether another 10-year bond needs to be issued. Going forward, IIBs would be issued at various maturity points and cater to the diverse market demand. Also, to garner greater retail participation, the central bank has decided to enhance the non-competitive bidding portion segment for retail segment investors to 20% from the current 5% level for auction of government of India securities. In fact, way back in 1997, the government had launched capital-indexed bonds that provided inflation protection only to the principal amount and not to the interest payments. As a result, the bonds reported lukewarm response from investors.
Why is the central bank calculating the interest on WPI and not on CPI
While globally CPI or retail price index is used by central banks for inflation target, in India all-India CPI is being released since January 2011 and it will take some time in stabilising, and even the monetary policy targets the WPI-based inflation. However, the central bank has said that it would look into CPI for the new instruments issued next year if the index stabilises. Since March this year, WPI has been trending down and in April fell to 4.89%, which is very much in the comfort zone of RBI. So, if the inflation rate falls further, investors appetite in IIBs may wane as bank fixed deposit rates are still high at around 8.5% for a more than one year tenor.
How will interest rate be calculated
RBI will first calculate the index ratio for settlement date by dividing the reference WPI for the settlement date by reference WPI for issue date, which will be WPI with a four months lag. For example, January 2013 WPI will be taken as reference WPI for June 1, 2013. The index ratio will be then be multiplied to the principal amount to get the inflation-adjusted principal amount. Then the semi-annual interest payment will be arrived at by multiplying the inflation-adjusted principal with the coupon rate.
Lets consider an example if someone who invests R1 lakh and if the coupon (again an example) is set at 2%. The reference WPI (four months lag) is set at 120 and the WPI for settlement day is set at 132. So, the index ratio will be 1.1 (132/120). Then multiply this to the principal of R1 lakh which then becomes 1,10,000. And then the semi-annual interest payment will be calculated by multiplying the inflation-adjusted principal amount of R1.1 lakh with half of 2% coupon rate. So, interest payment will be R1,100 (1.1 x 0.02/2).
What if the WPI series is revised
Actually, the WPI series is being revised after every 10 or more years. So, if there is any revision in the base year, an RBI note says, it would be tackled by splicing the base years so that a consistent WPI series with the same base year is available for indexation purpose since the issue date of the bond.
How can retail investors buy IIBs
RBI has devised a non-competitive bidding scheme for retail investors where they will have to indicate the amount of their bids and not the price at which they want to subscribe. Allocation of bonds to retail investors in this process will be done based on the weighted average price which emerges in the competitive bidding. Retail investors can participate in the non-competitive bidding through primary bond dealers or banks by opening a gilt account with the primary dealer or banks or demat account for such participation. For retail investors participating in non-competitive bidding, the minimum bidding amount will be R10,000 and the the upper limit is R2 crore, but for others buying in a secondary market or buying through a primary dealer auction, there are no limits. RBI is still working out all the methodologies of execution for retail investors like selling the bond through post offices as the logistics relating to that will have to tied up and will come out with more details soon. So, if the non-competitive bidding process sounds complicated for retail investors, then they should wait for the special retail issue in October or after that.
Can FIIs buy IIBs
FIIs can invest in IIBs but subject to the overall cap for their investment in G-secs, which is currently at $25 billion.
Will IIBs be traded in the secondary market
As these IIBs are government securities, they can be traded in the secondary market like other G-secs and investors will be able to trade them in Negotiated Dealing System (NDS-OM), NDS-OM (web-based), OTC market and the stock exchanges. Also, RBI has noted that in the market when it is bought and sold it can move over to any institutional investors. But in the second series, which will be specifically for the retail segment, there could be some restrictions and the final design is yet to come.
Will these bonds get any special tax treatment
No, there will be no special tax treatment for these bonds and investors will have to pay on interest payment and capital gains depending on their tax bracket.
Can companies also launch IIBs
Yes, they can, as RBI has underlined that financial products issued by corporates will be the prerogative of those companies subject to Sebi regulations. There will not be any requirement from the central banks side that it has to be exactly in line with IIBs. Recently, infrastructure major Larsen & Toubro issued 10-year inflation-linked capital-indexed debentures for R100 crore, which had a coupon of 1.65%.