Protection from Price Demon The proposed inflation-indexed bonds will make life easier for investors. We look at the mechanics of these debt instruments and how they will benefit you.

 


The Budget has proposed introduction of bonds or National Savings Certificates whose returns will be linked to inflation. In these instruments, the principal rises with inflation, though it is still not clear whether these bonds will be linked to the consumer price index (CPI) or the more closely-watched wholesale price index (WPI). The interest, called coupon, is calculated on the adjusted (to inflation) principal. The coupon rate may or may not rise with the price index.

For example, if the annual coupon is 8 per cent and the principal is Rs 100, the investor will be paid Rs 8 a year. If the inflation index rises 10 per cent, the principal will become Rs 110. The coupon will remain 8 per cent, resulting in an interest payment of Rs 110 x 8 per cent = Rs 8.8.

Inflation-indexed bonds give returns that are more than the rate of inflation, ensuring that price rise does not erode the value of investors' savings.

The exact structure of these instruments will be announced later.

Vivek Gupta, research head, CapitalVia Global Research, says, "This is encouraging for investors as most of the times the returns which investment funds showcase are not discounted for inflation. So, for a common man, it becomes difficult to know the real returns."

WHY INVEST

These bonds can be used to diversify and stabilise the portfolio. This is because their principal rises with inflation. But when inflation falls, the principal does not go below the issue amount.

These bonds are redeemed at the inflation-adjusted principal or the amount for which they were issued. "These bonds will give more choice to savers, particularly those who are risk-averse and looking to get assured positive real returns. Like gold, these are a hedge against inflation and store of value. Investors who desire predictable real cash flow can include indexed bonds in their portfolio," says KP Jeewan, head, fixed income, Karvy Stock Broking.

SPACE IN THE PORTFOLIO

How much a person should invest in these bonds depends upon his expectations about inflation. "Ideally, the entire fixed income component of a risk-averse investor's portfolio can be deployed in these bonds if they are offering an attractive yield over inflation," says Jeewan.

Market experts say these bonds are ideal for all investors. They have been structured for all individuals and institutions, as their basic purpose is to protect investors from inflation by giving fixed and regular coupon payments.

While the main aim of the government is targeting people who invest in gold to hedge their portfolios from inflation, it will be difficult for inflation-indexed bonds to completely replace the demand for gold. This is because most investors accumulate gold for consumption. This need cannot be substituted.


ROHIT SINGH
PGDM 2nd sem.