Inflation-indexed bonds from next month

In tranches; details issued on returns and structure; government hopes to wean investors away from gold and its import

The first tranche of inflation-indexed bonds (IIBs) would be issued on June 4, the finance ministry and the Reserve Bank of India (RBI) announced today.

“Pursuant to the announcement in the Union Budget 2013-14, the government, in consultation with RBI, has decided to launch (these) as instruments that will protect the savings of the poor and middle classes from inflation, and incentivise the household sector to save in financial instruments rather than buy gold,” said the announcement.

The returns would be calculated by using the rate of Wholesale Price Index-based inflation of the corresponding four months ago, it said. “Final WPI with a four-month lag will be used, that is September 2012 and October 2012 final WPI will be used as reference WPI for February 1, 2013, and March 1, 2013, respectively. The reference WPI for dates between February 1 and March 1, 2013, will be computed through interpolation,” said RBI.

The government has been planning such bonds to wean investors away from gold, soaring imports of which are considered to have led to the high current account deficit. India’s trade deficit widened to almost $18 billion in April on heavy gold import, according to data released on Monday.

Details
The IIBs would have a fixed real coupon rate and a nominal principal value that is adjusted against inflation. Periodic coupon payments would be paid on adjusted principal. “Thus, these bonds provide inflation protection to both principal and coupon payment. At maturity, the adjusted principal or the face value, whichever is higher, will be paid,” said the central bank.

The initial series would be for all categories of investors, including institutional ones. In the second half of the financial year, another series would be released exclusively for retail investors. The portion under non-competitive bidding, mainly for retail investors, has been raised from five per cent of notified value in the present issuance of bonds to 20 per cent for IIBs.

The first series would help in determining the coupon rate for the bonds through auction. This would help in benchmarking IIBs. Based on the experience in the initial issuances, a second series of IIBs for  retail investors has been proposed for issue around October.  

In the case of revision in the base year for the WPI series, a base splicing method would be used to construct a consistent series for indexation.

At present, 2004-05 is used as the base year for WPI.

The index ratio would be computed by dividing the reference index for the settlement date by the reference index for the issue date.

RBI said for appropriate price discovery and market development, it was necessary to issue comparable instruments through auctions to  institutional investors such as pension funds, insurers and mutual funds. This would create demand for IIBs and help in making these tradable in the secondary market. Each tranche would be issued through auctions on the last Tuesday of each subsequent month during 2013-14.

These issuance would target various points of the maturity curve to have benchmarks. To begin with, these bonds will be issued for a tenor of 10 years. Each tranche of IIBs would be for Rs 1,000-2,000 crore and the total issuance would be for Rs 12,000-15,000 crore in 2013-14, RBI said. The terms of issuance of IIBs for retail investors would be announced in due course.

Background
Lack of alternative financial instruments is often given as the reason for huge gold imports to hedge against inflation. However, many analysts and players believed the attraction towards gold will come down, as inflation is on a downward swing. WPI-based inflation plunged to a 41-month low of 4.89 per cent in April. Consumer price index-based inflation also fell to a 13-month low, of 9.39 per cent in April, though it still was at an elevated level.

India’s trade deficit zoomed to $17.8 billion in April, 27 per cent higher then the $14 bn in the same month last year. Imports were $41.95 bn, almost 11 per cent up over $37.8 bn a year before.

Imports of gold and silver jumped 138 per cent in April, due to the Akshaya Tritiya festival, considered an auspicious occasion to buy gold.

In April, India’s merchandise exports rose a marginal 1.7 per cent to $24.2 bn, against $23.8 bn in the corresponding month last year. However, imports surged a massive 10.9 per cent. In April, gold imports alone were $7.5 bn, against $3.1 bn in the year-ago period. This constituted nearly 25 per cent of non-oil imports.

The size of gold imports is worrying the government, as it widens the trade deficit and, in turn, the current account deficit. The latter  widened to a record 6.7 per cent of GDP in the third quarter of 2012-13. The government hopes CAD will not exceed five per cent of GDP in 2012-13. This year, it is pegged at below five per cent.