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All About Inflation Indexed Bonds in India

Inflation Indexed Bonds
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inflation indexed bondsDid you know the figures of Wholesale and Consumer Price Inflation, better known as WPI and CPI? You might be aware, as this is the hot topic in India these days. Anyways, for those who are still unaware, CPI in India ticked to just below 10% at 9.52% in August. All thanks to Onions, and spiraling Crude Oil prices of India. Meanwhile, WPI inflation was at 6.10% in August as per the latest figures. This has made a mockery of all kinds of investment options which were once seen as apples for the eyes of Indian investors. Be it, Equity markets, Mutual Funds, or Fixed deposits, no choice caters to the inflation problems of the country.  Neither do government policies!!!!

Now let’s come to the point, there is still hope for investors, if we take into account a niche medium of investing. This can turn out to be your portfolio hero in the current situation. The name is Bond, Inflation Indexed Bond. There are several things which an investor may be eager to know before investing in these bonds. The same is discussed below.

Real Hedge against Inflation:

With the prices of gold rocketing to nearly Rs 30,000 per 10 grams, Inflation Indexed Bonds in India is a much affordable option. The idea behind such bonds is that they take into account the inflation factor and save the principal as well as the interest rates from inflation threat. These products were earlier known as Capital Indexed Bonds (CIB).

How the returns get calculated?

The final figure of the Wholesale Price Index (WPI) is taken into consideration for calculating the return of the bonds. A fixed rate on the coupon is given on the basis of adjusted principal against the inflation. This can be understood with the help of an example. Mr. Mohan invested Rs 20,000 in inflation indexed bonds, at a coupon rate of 2%, now the calculation of the same is made on the basis of inflation index.

The principal adjustment is calculated as given below:

(Current Inflation Index / Inflation Index at the time of investment) * Principal invested.

Now, suppose the inflation index at the time of investment was 126, while currently it is 130, the calculation will be

(130/126) * 20000 = Rs 20,635, while the coupon rate interest will be Rs 20,635* 2% = Rs 412.7

The maturity period is 10 years, therefore, the adjusted period of maturity will be taken into account, in which the total interest due for 10 years based on the above calculations will be added to reach the final figure.

Issue Tenure and Size:

The bonds will be issued for a period of 10 years. At the initial stage, RBI has taken Rs 1,000-2,000 Crore as the size of issue in each tranche. FIIs have also been allowed to invest in inflation indexed bonds.

Some apprehensions among investors:

RBI has clarified on most of the common apprehensions of the investor of not using CPI as the mode to hedge inflation. According to the premier bank, CPI is being released from 2011 and is still in a stabilization stage. Meanwhile, monetary policy is formed on the basis of WPI inflation. Therefore, it will take some more time in coming out with Inflation bonds that take into account CPI inflation.

Taxation Check:

No special tax privilege is being provided in these bonds, which is another area of concern for the investors. Interest received and any capital gain occurring on the issue will be taxable under Income Tax Act, 1961. Another concern is that the regular interest in these bonds is lower than the FDs, because FD’s pay interest on a yearly basis, while here the interest rate is paid after adjustment at the end of tenure.

Although, taxation wise, these bonds do not lure investing class, it should be noted that a considerable period of inflation is anyways going to deteriorate the real returns. Those who are investing for a long term and have patience should go for these bonds. The core purpose of this bond option is to defeat inflation, which it is capable of handling effectively.

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