Time ripe for introducing inflation-indexed bonds, say market participants

With the rate of inflation back to double digits in just two years, demand for inflation-linked bonds is likely to be robust, say market participants. Keeping in mind the rising interest rate scenario, the Reserve Bank of India (RBI) has initiated discussions on introducing Inflation Indexed Bonds (IIBs) to deepen the government debt market.

IIBs are debt instruments issued by the government and the coupon rate is linked to the Wholesale Price Index (WPI). Such bonds were first issued in 1997 in the form of Capital Indexed Bonds, which witnessed a tepid response. RBI then issued a technical paper on IIBs, inviting suggestions and comments from market participants in December 2010.

RBI Governor D Subbarao on Tuesday said the central bank was in talks with the government and banks to introduce IIBs now, though the launch was not successful earlier. “Our view is that we have to test it (IIBs) once again. There might be a tipping point that didn’t work in the past but may well work on Tuesday, as conditions have changed,” he said.

Market participants said conditions were apt for introducing the IIBs. “These bonds have twin advantages. First, the rates are aligned to WPI, and second, mark-to-market is lower than in other government securities,” said a bond dealer with a large public sector bank.

The RBI governor said bankers had expressed concerns on the demand for these bonds since the floating rate bonds similar to IIBs were not doing well. But market participants are of a different view. “Investors are looking for instruments that can give good returns even in a high-inflation environment. So demand should not be a problem,” said a bond dealer with a domestic brokerage.

Also, hikes in deposit rates by banks have seen good response from investors. According to RBI data, the deposit grew 18.4 per cent as on July 1, 2010, as compared to 17 per cent just two months ago.

“There could be a good demand now if the issue size is between Rs 2000-2500 crore at around 8.50-8.60 per cent levels,” said the bond dealer.

According to the technical paper issued in December 2010, final WPI with a lag of four months will be used as the Reference WPI for the first day of the calendar month in which ‘Issue Date’ and ‘Set Date’ falls. In June 2010, provisional WPI was at 9.44 per cent which economists say will touch double digits on revision.