CPI-linked bonds an excellent bet
For those in the lowest tax bracket, it may even be the go-to investment. After a few failed attempts, an investment that really can be a hedge against inflation is finally here.
The belief in gold as a hedge against inflation has never stood up to critical analysis. But the RBI WPI-linked inflation bonds were too inadequate to get most to stop relying on gold. That’s because the WPI or the Wholesale Price Index is far lower than the real rate of inflation, as estimated by the Consumer Price Index (CPI).
Two months ago, the new RBI governor Raghuram Rajan finally discussed the idea of CPI-linked inflation indexed bonds and by the second half of December, the first scheme is expected to be launched. And as per the release from the RBI, it looks to be an excellent investment.
How it works?
Returns: The CPI-linked bonds will earn a variable return identical to the CPI as well as a fixed return on 1.5%. So if CPI for a particular month is 9%, the bond would earn 10.5% for that month. However, it will have a lag of three months. So the final CPI for September will be the reference point for returns in December 2013. The returns will, therefore, be variable. As inflation is high, returns will be on the higher side. But if it moderates, returns could even be lower than those from bank FDs.
Availability: These bonds, the RBI says, will be sold through banks. If this is the case, the transaction may be easier to do than a bank FD, with a higher return, too.
Tenure: This won’t be any short-term investment. The bonds will have a 10-year maturity. You may exit prematurely, but not before one year for those over 65 years and three years for those below 65 years. Returns will be compounded half-yearly and paid out on redemption. Early redemptions can be done, but only once every six months (on the coupon date). You can get a loan against this investment.
Penalty: In case of premature withdrawal, there is a penalty even after the lock-in. It will be charged at the rate of 50% of the last coupon payable for early redemption.
Tax: There are no benefits. The RBI’s release says that the tax treatment would be ‘as per the extant taxation provision’. So, as with bank FDs, you pay tax on the interest you earn at the slab rate. As the amount gets reinvested, you pay tax on the interest deemed to have been generated. So you’ll have to pay tax on the interest you earn for 10 years while having access to the money only on maturity.
Liquidity: A potential problem. 10 years is a long time and most of us will not be able to say for sure that they will not need to be redeemed prematurely. After three years, the lock-in does come to an end, but the penalty – of 50% of the last coupon payable – is a hefty one and redemptions can be made only once every six months.
Investment limit: A minimum of Rs5,000 and maximum of Rs5 lakh per year can be invested in the IINSS-C.
What experts say
Sanjay Matai, Founder, The Wealth Architects, says that it’s a completely new product and should be of interest to investors, particularly those in the lowest tax bracket. He says, ‘This is a much-needed product and will be of great value to those in lower tax brackets. If inflation is as high as it is today, it’s a good way to keep up. Those in the highest tax brackets, on the other hand, might currently find tax-free bonds more valuable. As for liquidity, it could be a problem. Whether or not these will be sellable on the bond market will depend on how investors respond. As for now, all debt investments are illiquid.’
Sunil Wagle, CFP, Money Managers, says, ‘It’s a good step by the RBI. Until now, people were foolishly dependent on gold as a hedge against inflation, which didn’t work. While investors will still be unhappy that the returns are fully taxable, do consider that the returns will nonetheless be good, particularly for those in the lowest income bracket.’