Sunday, September 15, 2013

Inflation Indexed Bonds (IIB) to fight back inflation

Inflation Indexed bonds are the new bonds issued by the Government of India in order to protect the assets of people from the losses on account of inflation.
     Would you really like to get rid of inflation, the cancer which corrodes your assets?  If yes, the appropriate investment method for you is Inflation Indexed Bonds (IIB).  IIBs are government sponsored bonds that offer protection from the loss on account of inflation.  The Government of India and Reserve Bank of India (RBI) are all set to launch a special issue for common investors in October this year. 

     Fixed deposits in banks, the way people widely follow for their investment plans, provide 9-10% interest though, in fact, the real benefit they get is up to 1% only.  Because the inflation rate is approximately 8% per each year and the real profit an investor gets is the amount after deducting the inflation rate.  Since 15-20% profit is expected from share business and mutual funds, those investment methods are capable to overcome the loss on account of inflation.  But, as the possibility of loss is far high in these sectors, majority of common investors are still not interested to invest in such ways.  Here is the relevance of secured investment method that has the capability to overcome the inflation.
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     It is a long awaited need of common people that the Government fulfilled through launching IIB.  Although RBI initiated IIB for the first time in June 4, there was only a meager share provided for the small scale investors.  Now RBI is going to initiate a special issue for small scale investors in October.  Moreover, RBI is looking ahead to sell out the bonds of Rs 15,000 Cr in the current fiscal year.

What is IIB and how?
     Inflation Indexed bond is a bond instrument issued by government.  Similar to prevalent government sponsored securities, IIB is also a type of bond that has a face value.  This face value is connected to the inflation.  Therefore, when the inflation rate increases, the face value also will go up and when the inflation rate decreases the face value will go down.  Interest/coupon rate will be declared at the time of issue.

     Bonds are issued for a span of 10 years. In this span, interest will be given for the face value in coupon rate.   When the span completes, real face value or inflation indexed face value of that time, which one is higher, will be returned the investors.

How to invest?
     Last time, it was by submitting bids through the primary dealers, the issue targeted for the institutions was launched.  Now, the authorities notify that there will have the convenience for more feasible transactions in the upcoming issue for the small scale investors. 

More Benefit through transactions
     The attraction of these bonds is not only the income through interest.  These bonds can be sold and bought back again as it is done in share business. Therefore, it will be listed in stock exchanges as well.  It will have more liquidity as it is a plan that can be transformed to money at any time.   Most recently,  IDBI bank arranged a new online portal, named ‘Samrudhi,’ in order to provide the investors the convenience to execute the IIB transactions more easily.  At present, as part of its publicity, the bank doesn’t levy any brokerage fee for this service. 

     Besides its all benefits, like any other bonds, IIBs also have some demerits.  The prominent one is that the bond is issued after connecting it with wholesale price index (WPI).  As far as the common people are concerned, the WPI is not much related to their day-to-day life.  It is consumer price index (CPI) that hits his backbone. Therefore, according to experts, the real benefit can be achieved through connecting the bond to the CPI other than WPI.  

     Income tax is the other nightmare.  Income tax is levied for these bonds and the real profit of the investor will be the amount after deducting the income tax.  A capital gain tax also is to be paid for the profit made through transactions of these bonds in secondary market.  

Substitute to gold
     As an investment method that protects investors’ asset from the tentacles of inflation, these bonds have high news value nowadays.   At present, it is gold that has been depended to fight back the inflation.  But the gold price is surged to a level that is not affordable for a commoner due to high volume of purchase of government and people. This was because of the prevailing instability that the economy is in the shadow of a recession.  That situation led to increasing the amount of gold import and decreasing the value of foreign currency collection substantially. And the attempts to control ‘gold mania’, that is obviously a threat even to the financial stability of the country, didn’t find success at all.  It is in this context the government of India comes forward with the new bonds that is expected to protect the people’s assets from inflation.  The bonds are also aimed to get reduced the undeserved importance given to the gold at present.

     This new investment tool is beneficial for the government as well as the investor.  The government is able to raise funds without much effort in a situation that the instability on increasing mode.  The investor is getting rid of the inflation head-ache as well!

Related articles : 
1. What is mutual fund?
2. What is share market?


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