Q. With reference to the Indian economy, what are the advantages of "Inflation-Indexed Bonds (IIBs)"? - Government can reduce the coupon rates on its borrowing by way of IIBs.
- IIBs provide protection to the investors from uncertainty regarding inflation.
- The interest received as well as capital gains on IIBs are not taxable.
Which of the statements given above are correct? (UPSC Prelims 2022)
Answer:
1 and 2 only
Notes: The correct answer is
[A] 1 and 2 only. Inflation-Indexed Bonds (IIBs) are debt instruments designed to protect both the issuer and the investor from the negative effects of inflation.
- Statement 1 – Correct: Since IIBs provide a hedge against inflation, investors are often willing to accept a lower "real" coupon rate compared to nominal bonds, which must include a high inflation risk premium. This allows the government to reduce the coupon rates (interest costs) on its borrowings, especially during periods of volatile inflation.
- Statement 2 – Correct: The principal and/or interest payments in IIBs are linked to an inflation index (like WPI or CPI). This ensures that the purchasing power of the investor's capital is maintained, providing a built-in safeguard against rising prices and economic uncertainty.
- Statement 3 – Incorrect: There is no general tax exemption for IIBs in India. The interest income received is typically taxable as per the investor's applicable tax slab, and any capital gains are subject to capital gains tax. While some specific historical schemes (like the Inflation Indexed National Savings Securities) offered certain benefits, the standard IIB framework does not grant tax-free status to interest or capital gains.