‘If indexation benefits are available on these bonds, then there will be a huge demand from individual investors’

The much-publicised Inflation-Indexed Bonds (IIBs) failed to attract investor interest, either retail or institutional, in the last financial year. The Reserve Bank of India (RBI) is now planning to re-launch this product in a restructured form.

Globally, inflation-indexed bonds are much in demand since they provide investors an inflation hedge providing real interest rate returns.

IIBs were primarily issued to institutional investors, and initial auctions worth Rs.6,500 crore received a muted response. Arun Khurana, Country Head, Global Markets Group, IndusInd Bank, felt the main reasons for this was IIBs were primarily linked to wholesale price index (WPI) and not consumer price index (CPI).

“There is uncertainty of cash flows. Future cash flows accruing to the bond are not known, and there are no systems for internal valuation of the bonds. There is also absence of secondary market trading,” he pointed out.

Retail segment

For the retail segment, Inflation Index National Savings Securities, (linked to CPI) were available to the tune of Rs.1,000 crore.

“The poor appetite is mainly because it is not transferable, that is, it cannot be traded in the secondary market and premature redemption is allowed only after three years with a penalty,” Mr. Khurana added. It will be difficult to quantify the exact demand for the product, but with the gross borrowing programme at Rs.6 lakh crore (approximately), “this could catch the interest of investors provided there is sizable liquidity created through continuous issuances”.

Further, investors in these bonds would be insurance companies, pension funds, banks for their SLR portfolios and FII’s.

“If corrective action is taken, I would foresee these bonds garnering investor interest,” said Mr. Khurana.

In 1997, IIBs were issued in the name of Capital-Indexed Bonds (CIBs) but failed to attract investors.

According to Mr. Khurana, the main reason for its lack of demand is attributable to its nature, that is, “only protection of capital against inflation and not the coupon”.

Any such instrument that is introduced in the market needs to serve a dual purpose, that is, be investor-friendly and be adequately attractive to brokers / distributors.

There are a slew of investible products in the market. “Therefore, for investors, the attractiveness of the product is important to highlight,” said Anis Chakravarty, Senior Director, Deloitte Touche Tohmatsu India Private Limited.

While the RBI tried to tailor the structure by raising the investment cap and offering a higher brokerage, it still fell behind in certain respects, said Mr. Chakravarty. According to him, liquidity aspects of the instrument, particularly around interest payouts, were important.

Further, taxation issues needed to be ironed out. Another important factor was that inflation itself had declined over the past few months. Mr. Chakravarty said the timing of introduction of such a product vis-à-vis its attractiveness, needed to be better understood.

The biggest shortcoming of the IIBs in the current format was the taxation issue, said Umang Papneja, Chief Investment Officer, IIFL Private Wealth. On a post-tax basis, there were many instruments offering better returns than the IIBs, he said.

Long-dated FMPs (fixed maturity plans) and tax-free bonds were some of these instruments, he pointed out.

The bonds now offered did not have indexation benefits. “If indexation benefits are available to investors on these bonds, then there will be a huge demand from individual investors,” Mr. Papneja said.

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