Moody's positive on inflation-indexed bonds

Says the WPI-linked bond would help cut gold imports drastically

Global rating agency Moody's today said that inflation index bond (IIB), which the Reserve Bank of India(RBI) issued a week ago, has added to the economy a "credit-positive financial diversification".

Terming the move by the Government as a "radical policy adjustment", the rating agency said, "Inflation-indexed bonds, if deployed in conjunction with other measures to correct macroeconomic imbalances, will become an effective, credit-positive addition to Indian authorities’ policy tool kit."

The government, to divert people from investing in gold and to guard investors against inflation had issued the IIBs. These 10-year bonds were subscribed more than four times in its first auction last Tuesday.

Moody's said that it will help solve many problems at the macroeconomic level. "If inflation-indexed bonds reduce domestic investor demand for gold as an inflation-hedge asset and reduce gold imports, it would alleviate balance of payments and exchange rate pressures", it said.

It added that the Indian household, which has a long-standing preference for gold as an asset, may switch their investments from the yellow metal if they "are persuaded that inflation-indexed bonds are an effective hedge against inflation."

Moody's, however, also said that gold imports, in the recent times, can come down because of the recently extended import curbs rather than the inflation-indexed bonds. The rating agency predicted that as a result, the gold imports will come down to Rs.150 billion from their earlier estimate of Rs.3 trillion.

The government has taken various steps in lieu of curbing high gold imports. Last week, it had also raised the import duty on gold to 8% from 6%. 

In 2012-13, gold accounted for 11 % of India’s imports. The imports also lead to the trade deficit widening to an unprecedented $190.4 billion. India's current account deficit(CAD) could also be affected as a result of this. The CAD was at a record 6.7 % of gross domestic product in the third quarter of 2012-13. RBI had also banned its import on a consignment basis (where the importing bank doesn’t have to fund it till actual sale) and disallowed any credit facility. IIBs were one such measures.

The second series of bond issue will begin in October, where these bonds would be reserved exclusively for retail investors.

All in a Bond

Inflation-indexed bonds would be linked to wholesale price index (WPI) inflation

Bonds would have fixed real coupon rate, nominal principal value which would be adjusted against rate of inflation

Periodic coupon payments are paid on an adjusted principal

Aforementioned bonds provide inflation protection to both principal, as well as coupon payment

Since coupon would be paid on adjusted principal, final yield, or cash the investor receives in hand would fluctuate depending on the WPI movement.

On maturity, investor would receive adjusted principal or face value, whichever is higher