To protect households against negative returns on their savings, the Reserve Bank of India will launch retail inflation-index bonds in mid December. Investors can buy these 10-year bonds from banks and the interest rate on these securities will be linked to the final combined Consumer Price Index (CPI) with a three-month lag, plus 1.5%, compounded in the principal on a half-yearly basis and paid at the time of maturity.
The face value of one Inflation Indexed National Savings Securities-Cumulative (IINSS-C) security will be R5,000 and the minimum investment will be R5,000. An applicant can invest a maximum of R5 lakh in a financial year. These bonds can be pledged as collateral for loans from banks, financial institutions and non-banking financial institutions. Like relief or savings bonds, individuals, Hindu undivided families, charitable institutions registered under Section 25 of the Indian Companies Act and universities incorporated by central, state or provincial Acts or a university under Section 3 of the University Grants Commission Act can subscribe to these bonds.
It is mandatory for an investor to quote his or her permanent account number (PAN) if the investment amount is more than R50,000. A person who does not have a PAN will have to give a declaration in Form 60, as per Income Tax Rule 114B. While quoting PAN is not required for those who have only agricultural income and not any other income, the individual will have to give a declaration in Form 61. The RBI said the tax treatment on interest and principal repayment would be in line with the extant taxation provision, where investors will have to pay tax on interest and capital gains depending on their tax bracket.
Early redemption will be allowed after one year from the date of issue of the bonds for people above 65 years of age. For others, it will be three years from the date of issuance. Early redemption, however, will be subject to penalty charges at the rate of 50% of the last coupon payable and can be made only on the coupon dates. An individual can nominate one or more persons who will be entitled to the bonds and receive the payments in case of the original bondholder’s death.
The RBI circular has underlined that the final combined CPI with a lag of three months will be the reference CPI. For instance, the CPI for September will be used as reference for bonds issued in December this year. Retail inflation, based on CPI, was 9.84% in September, which accelerated to 10.09% in October mainly on account of higher fruit and vegetable prices.
For the inflation-index bonds issued earlier, the RBI had devised a non-competitive bidding scheme for retail investors where they had to indicate the amount of their bids and not the price at which they want to subscribe. Allocation of bonds to retail investors in this process is done based on the weighted average price that emerges in the competitive bidding. Retail investors can also participate in the non-competitive bidding through primary bond dealers or banks by opening a gilt account with the primary dealer or banks or a demat account for such participation.
Analysts say retail investors will find it easier to buy these bonds from banks. They say post offices should also have been included as distributors considering their reach. “At present, these bonds will be better than fixed deposits, but if the CPI falls drastically, then bank fixed deposits would be more attractive,” said Vipul Sharma, an independent financial adviser.
Analysts also say that the biggest advantage of CPI-index bonds is that it will give the right reflection of the price hikes that consumers have faced in the recent past. Globally, CPI or the retail price index is used by central banks for targeting inflation. Countries like the UK, US, Germany, France, Canada and Japan have introduced IIBs many years ago as a new retirement savings tool.
The government proposed inflation-index bonds in the Budget to protect retail savings from inflation, incentivise households to invest in financial instruments and reduce the physical holding of gold as the record import of the yellow metal widened the current account deficit to $88 billion in 2012-13, or 4.8% of GDP compared with $78 billion (4.2% of GDP) in 2011-12. In June, the RBI launched the first tranche of the bonds to provide inflation protection to both the principal and interest payments and the bonds were linked to the Wholesale Price Index.
In fact, way back in 1997, the government had launched capital-indexed bonds that provided inflation protection only to the principal amount and not to the interest payments. As a result, the bonds evoked lukewarm response from investors. But this time, the bonds will provide inflation protection to both principal and interest payment and further, linking it to the CPI will attract retail investors and get them inflation-protected returns in the long run.
* RBI will launch retail inflation-index bonds in mid December. Investors can buy these from banks
* These bonds will offer households a shield against negative returns on their savings
* The 10-year bonds will have a face value of R5,000
* Investment in the bonds has been capped at R5 lakh per applicant per year
* Interest on these securities would be based on the CPI with a three-month lag
* Quoting PAN is mandatory if the investment amount is more than R50,000 per year