The Reserve Bank of India (RBI) will launch an improved version of its inflation-indexed bonds (IIBs) later this month. First launched earlier this year, IIBs were linked to the wholesale price index (WPI), and proved a damp squib.
So, in order to woo consumers and wean them off gold, the RBI has benchmarked the new version of IIBs against the consumer price index (CPI).
Financial experts are unanimous that the CPI-linked IIB will prove to be a better product than the WPI-linked bond. So, should you bet your money on it? Not before you get to know the new bond intimately.
Experts believe post-tax returns on CPI-linked IIBs may not be very attractive. For, the rate of interest will be the inflation rate plus a fixed rate, which is going to be 1.5%.
Now, the CPI used in this case will come with a lag of three months. For example, September’s CPI would be used as the reference point for December.
Assuming that you are in the highest tax bracket (30%) and the interest rate applicable is 11.5% (10% CPI + 1.5% fixed rate), the post-tax returns work out to 8.17%.
For someone in the 20% tax bracket, the post-tax returns will be 9.39%. So, in both cases, CPI-linked IIBs would not provide relief from inflation. But, if you are in the lowest tax bracket (10%), then returns at 10.6% would beat inflation.
Financial advisers say that CPI-linked IIBs score better when compared with fixed deposits or FDs; but they appear to pale in comparison to tax-free bonds or a public provident fund (PPF).
Suresh Sadagopan of Ladder Seven Financial Advisory Services believes that CPI-linked IIBs can be a good substitute for FDs but not PPF or tax-free bonds, particularly for people in the higher tax brackets.
Harsh Roongta, CEO of apnapaisa.com, points out that the interest rates will be variable depending on the CPI. As a result, your returns will vary, and this can prove to be a deterrent.
“Historically, floating interest rate products have never been successful in India. CPI-linked IIBs may not be any different.”
Even without any real income, there will be tax outgo on CPI-linked IIBs every year, says Roongta. “The interest is accumulated, so you will get it only at the end of the term, which is ten years with a minimum lock-in of three years. The lock-in for senior citizens (aged 65 and above) is one year.
But, at the same time, you will have to keep paying taxes every year even without any real income.”
Experts also believe that CPI-linked bonds will not be able to wean people off gold. For, the product will face stiff operational challenges. If banks are not offered adequate incentives, it is likely that the CPI-linked IIBs may well go the National Pension System or NPS way, a failure.
Other procedural hassles like the need to open a bond ledger account and pay fine for early redemptions, could work against CPI-linked IIBs.
Inflation bonds in a nutshell
Rs 5,000 Minimum investment
Rs 5,00,000 Maximum investment
Tenor - ten years
Expected launch - the second half of this month
Key features - can be used as collateral from banks, NBFCs; early redemption will attract a penalty of 50% of the last coupon payable.