Inflation-beaters in the works

Though still in discussion stage, these instruments can be supplements to gold

To encourage households to save in financial instruments, rather than buy gold as a hedge against inflation, the government is planning to introduce inflation-indexed bonds or inflation-indexed national security certificates. This will be done in consultation with the Reserve Bank of India, said Finance Minister P Chidambaram, in his Budget speech. The structure and tenor of the instruments will be announced in due course.

"The private sector, comprising households and corporates, remains the main contributor to saving. The household sector must be incentivised to save in financial instruments rather, than buy gold," he said.

With Wholesale Price Index (WPI) inflation between seven and eight per cent and Consumer Price Inflation (CPI) in double digits for a major part of the year, returns from instruments like fixed deposits had turned negative. This saw investors opting for physical assets like real estate and gold.

"The use of gold as a hedge against inflation is a burden on the economy and is unproductive. Therefore, instruments like inflation-index bonds can help the government reduce the import bill," said the head of treasury of a public sector bank.

These bonds will be linked to either the WPI or CPI and the coupon rate reset on a periodic basis. The coupon rate will move in line with inflation.

They could be similar to Floating Rate Bonds, which are linked to Mumbai Inter Bank Offer Rate.

But FRBs have not been very popular, as they are complicated and difficult for investors to understand. So, unless the inflation -indexed bonds have a simple structure they, too, might not find many takers. Ideally, the tenure of such bonds should be long-term, at least 10 years, since the impact will not be seen in short-term instruments. "Over a period of one year, inflation rates move in very small quantum," the bank official said.

However, according to Rajiv Bajaj, vice-chairman and MD, Bajaj Capital, the tenure of such instruments should not exceed three to five years.

"There is a demand for instruments that offer capital protection. But investors are not comfortable locking into very long tenures. For instance, capital protection funds by mutual funds, which were popular, are of three-to-five year tenures,'' Bajaj said.