Inflation Indexed Bonds

Inflation Indexed Bonds or Inflation Indexed National Savings Securities-Cumulative (IINSS-C) are a type of bond that provides inflation protection to its investors on both principal and interest payments. These bonds were issued in the name of Capital Indexed Bonds (CIBs) during 1997. It offers a fixed rate of 1.5% p.a. above the inflation rate measured by the Consumer Price Index (CPI). Unlike regular bonds, the face value of the bonds increases with inflation and therefore, the principal amount increases. At maturity, investors receive the adjusted principal, ensuring that their investment isn't eroded by inflation.

The earlier version of this bond was linked to the Wholesale Price Index (WPI). The RBI has not issued new Inflation Indexed Bonds since 2014 due to low liquidity, low retail demand and complex structure.

The Government of India decided to launch Inflation Index Bonds, pursuant to the announcement in the Union Budget 2013-14, to protect the savings of the poor and middle classes from the impact of inflation. Further, this bond would encourage investment in financial securities rather than buying gold. The purpose of IIBs was to provide a fixed interest rate and protect the principal from inflation. It allows investors to diversify their portfolios with government-backed securities even in times of high inflation. Initially, these bonds were linked to the WPI but were later aligned with CPI.

Inflation Indexed Bonds were subsequently discontinued in India due to low retail participation, complexity of the securities and moderation in inflation, leading to low trading volume in the secondary market. These bonds were first issued in 1997 under the name of Capital Indexed Bonds, but they failed to gain popularity as they protected only the principal from inflation and not interest payments.

The government later repurchased the bonds in 2016 (1.44% Inflation Indexed Government Stock-2023) through reverse auction for an aggregate amount of Rs 6,500 crore (face value). The bonds were prematurely redeemed using surplus cash balances.

Investment Limits

The minimum investment amount for inflation indexed bonds is Rs 5,000. The eligible individual investors can invest up to Rs 10 lakh per year, while institutional investors (such as Charitable Trusts, HUFs, Education Endowments) can invest up to Rs 25 lakh per year.

Linkage to Consumer Price Index

The bonds provide interest to its bondholders at the fixed rate of 1.5% p.a. plus CPI inflation rate [(CPI) Base 2010 = 100]. This 1.5% p.a. is fixed even in a deflationary environment. The final combined CPI will be used with a lag of 3 months to calculate the incremental inflation rate. For insurance, the final combined CPI for September would be used as the reference CPI for December.

Interest Payment & Redemption

The interest on inflation bonds is compounded on a half‐yearly basis. On redemption, bondholders will get the compounded interest with the principal on maturity.

Premature Redemption

The maturity period of IIBs is 10 years. However, bondholders have the option for early redemption of their bonds after the completion of 3 years. Senior citizens aged above 65 years can prematurely redeem bonds after 1 year. Bondholders are charged a penalty at the rate of half of the last payable coupon paid. Bondholders can contact the concerned bank for premature redemption and provide a Letter of Acquaintance, confirming the NEFT account details, etc.

Tax Treatment

The interest on RBI Inflation Indexed Bonds is taxable under the Income Tax Act, 1961, as applicable according to the relevant tax status of the individual. These bonds are also subject to the capital gains tax when sold in the secondary market.

Collateral

Bondholders can use their inflation bonds as collateral for loans from financial institutions, banks and Non Banking Financial Companies (NBFC).

Investment Channel

Investors can invest on inflation indexed bonds through the authorised banks and the Stock Holding Corporation of India (SHCIL). An application form and the necessary documents are required to be submitted and payment to the bank.

Based on the money receipt, the bank will register the investor on the web-based platform (E-Kuber) of RBI and, on validation, generate the Certificate of Holding. These bonds were issued in the form of Bonds Ledger Account (BLA) and the RBI acts as a central depository. As for now, no new inflation indexed bonds have been issued in India since 2014.

Inflation Indexed Bonds were introduced to protect the savings of an investor from the impact of inflation and ensure stable, assured returns by providing a fixed rate of return. As these bonds are no longer issued in India, conservative or long term investors should focus on investing alternatives that can provide returns above inflation, i.e., a mix of debt mutual funds, government-backed bonds and long term equity exposure. A smart asset allocation and periodic portfolio review can help investors manage inflation risk.