RBI to launch CPI-indexed IIBs

November 27, 2013

The Reserve Bank of India will launch CPI-indexed Inflation Indexed Bonds (IIBs) aimed at protecting the savings of retail investors from the impact of inflation by the end of December 2013.
According to RBI Deputy Governor H R Khan the amount of this year’s IIBs would be between Rs 10,000-15,000 crore (wholesale price and consumer price indexed bonds) but exact amount is yet to be decided.
In October, 2013, the RBI said in its policy statement that inflation-indexed securities for retail investors of 10-year tenor would be linked to the new (combined) Consumer Price Index (CPI).
As per the statement, the interest would be compounded half-yearly and paid cumulatively at redemption.

What are Inflation-Indexed Bonds (IIBs)?

Inflation-Indexed Bonds or IIBs are bonds where both the principal and the interest are indexed to inflation. In this way it is different from the Capital Indexed Bonds (CIBs) issued in 1997 which provided inflation protection only to principal and not to interest payment. These are thus designed to cut out the inflation risk of an investment. These bonds will be linked to the inflation index of the country and serve as a better investment option as compared to physical assets like real estate and gold. Higher the inflation, the higher would be the returns.
Note: While the first series of IIBs which was open to all categories of investors was indexed to Wholesale Price Index (WPI), the second series which will be launched by December end this year will exclusively for retail investors and it will be indexed to the new (combined) Consumer Price Index (CPI).

Why this step by RBI to launch Inflation Indexed Bonds (IIBs)?

The step is being taken to de-motivate investments in gold as bulging imports of the yellow metal has been adversely affecting the country’s Current Account Deficit (CAD), which had surged to a historic high of 6.7% in the third quarter of 2012-13. In May 2013, imports of gold and silver soared by 138% on an annual basis to $ 7.5 billion.

How would Inflation Indexed Bonds (IIBs) help?

As per RBI, IIBs would help in:

Boosting domestic savings and reversing the declining savings-to-GDP ratio.
Providing households and other investors a competitive option against gold and real estate. In the wake of rising inflation last year, there was considerable flow of investments from financial savings to safe-haven assets like gold that resulted into higher imports of the metal. This led to current account deficit or CAD widening to 4.9% of GDP at the end of September 2012.
Giving investors choice to use IIBs as good hedging instruments against inflation.

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