By Vaibhav Anand, IFMR Capital
In line with Budget announcement by Finance Minister in February, Reserve Bank of India (RBI) announced to issue INR 12,000 crore to INR 15,000 crore of inflation indexed bonds (IIB) on 4th of June of the current year (2013). The proposed issuance is available for bidding to institutional as well as retail and mid-segment investors. The non-competitive segment would be 20% in order to encourage the retail participation. Further RBI envisages opening this product exclusively for retail offering in its proposed second issuance in October.
The coupon rates will be determined by auction of bonds, that’s why RBI is intentionally offering it to institutional investors to determine the pricing of these bonds in the first round. Real coupon rate will be applied to inflation adjusted principal to calculate the periodic semi-annual coupon payments. Further, the principal repayment at maturity would be inflation-adjusted principal amount or its original face value whichever is greater, thus there exists an inbuilt hedge for capital protection. However, these protections would be provided with respect to Wholesale Price Index (WPI) with four weekly averages of four month lag. This means that the hedge may not be perfect if the actual inflation rate differs from the WPI, which is likely to be the case for the retail investors. Also, the IIBs may not be sufficiently liquid; in general the long term debt market in India suffers from lower investor base and lower liquidity. This coupled with the 10 year tenure of initially offered IIBs may not make this an attractive instrument for the retail investors. However, the option to invest indirectly in IIBs through the investment funds (e.g. mutual funds) may provide a solution to the liquidity problem.
The issuance of IIBs by the government of India may be termed as a plan to borrow under the garb of protecting the retail investor from increasing prices or reducing the trade deficit by offering IIBs as an option in place of gold. Nevertheless it is a great step towards long term debt market reforms. RBI has mentioned that it may consider in future moving from WPI to consumer price index (CPI) once the latter is stabilized. Unless the issues of benchmark inflation rate and liquidity are addressed, the IIBs may not be an attractive investment for the retail investors.