The bonds are being launched to discourage investments in gold as whopping imports of the yellow metal have been adversely impacting Current Account Deficit

There’s now an alternative avenue for those who in recent times were going in for investment in gold as a hedge against inflation. As promised by Finance Minister P. Chidambaram in the Union budget for 2013-14, the government on Wednesday decided to launch Inflation Indexed Bonds (IIBs) to wean away investors from the yellow metal to paper-based savings instruments.

The Finance Ministry in a statement said: “…the Government of India, in consultation with the Reserve Bank of India, has decided to launch IIBs, as instruments that will protect savings of poor and middle classes from inflation and incentivise the household sector to save in financial instruments rather than buy gold.”

Starting June 4, the RBI will launch IIBs each month with a maturity period of 10 years with the primary objective of weaning away household savings from gold to these hedged bonds up to Rs.15,000 crore this fiscal.

According to the apex bank, the first tranche of IIBs-2013-14 for Rs. 1,000-Rs. 2,000 crore will be issued on the first Tuesday of June, after which the bonds will be issued on the last Tuesday of each month for a total issue size of Rs. 12,000 crore-Rs. 15,000 crore for 2013-14.

Open to all

The first series of IIBs will be open to all classes of investors, including institutions, pension funds and insurance, while the second series, starting October this year, will be reserved for retail investors.

This is being done for appropriate price discovery and market development. That is why “it is necessary to issue comparable instruments through auctions to institutional investors such as pension funds, insurance, and mutual funds as it will create demand for IIBs and help in making them tradable in the secondary market.

“It is therefore proposed to issue an initial series for institutional investors (including 20% to retail investors) and later, another series, exclusively for retail investors. The first series of IIBs would be issued in H1 of the current FY. With a view to targeting greater retail participation in this series also, it has been decided to enhance the non-competitive segment for retail investors to 20%, from the present level of 5%,” the statement said.

Terms of issuance of IIBs for retail investors will be announced in due course.

Clearly, the bonds are being launched to discourage investments in gold as whopping imports of the yellow metal has been adversely impacting the country’s current account deficit (CAD), which had widened to a historic high of 6.7 per cent in the third quarter of 2012-13. Last month, imports of gold and silver zoomed by 138 per cent on an annual basis to $ 7.5 billion.

While both the government and the RBI have been taking steps to check the runaway increase in gold imports on account of largely speculative investment, hedge against inflation and general demand for jewellery, the demand does not appear to be falling to the extent desired. That is one of the reasons that the apex bank imposed restrictions on banks importing gold. However, the fact remains that while the IIBs are expected to attract those savings which were finding their way to gold investment, analysts feel that speculative investment may not get adequately curbed.

This is for the simple reason that while the bonds will insulate the savings from the draconian tax of inflation, they would not provide any returns by way of additional profits as gold has provided during the last decade.

How does the government propose to insulate investors through the indexed bonds? The government has stated that that the Capital Indexed Bonds (CIBs) have a fixed real coupon rate and a nominal principal value that is adjusted against inflation. Periodic coupon payments are paid on adjusted principal.

“Thus, CIBs provide inflation protection to both principal and coupon payment. At maturity, the adjusted principal or the face value, whichever is higher, will be paid.”

Index ratio

The IR (index ratio) will be computed by dividing reference index for the settlement date by reference index for the issue date, and the final inflation data based on the Wholesale Price Index (WPI) will be used for providing inflation protection. Besides, in case of revision in the base year for WPI series, base splicing method would be used to construct a consistent series for indexation.

As for the indexation lag by way of availability of the final numbers, the final WPI with four months lag will be used, that is, September 2012 and October 2012 final WPI will be used as reference WPI for February 1, 2013 and March 1, 2013, respectively.

The reference WPI for dates between February 1 and March 1, 2013 will be computed through interpolation.

More In: Economy | Business