Inflation bonds will get you a measly 1.4% interest. So forget it

FP Staff • December 21, 2014, 02:34:37 IST

The Reserve Bank of India set the real yield at 1.44 percent at the first auction of its new series of inflation-indexed 2023 government bonds on Tuesday, lower than the expected 1.7 percent in a _Reuter_s poll.The Rs 10,000 crore auction was fully subscribed. The fixed real rate is determined by bids at the first auction. This rate does not take inflation into account and will remain constant for the bond tenor.

Inflation bonds will get you a measly 1.4% interest. So forget it

The fixed real rate is determined by bids at the first auction. This rate does not take inflation into account and will remain constant for the bond tenor. In the first series, the tenor will be 10 years. Interest will be paid half-yearly. Inflation will be accounted for through adjustments to the amount invested (nominal principal value).

The real yield is the annualised yield, discounting the inflation. In the case of IIBs issued by the RBI today, it can be explained as the the spread above the WPI. However, such a low coupon rate implies that you will not get more than 1.5-2.5 percent yield anytime in the initial years - unless inflation roars suddenly.

According to the RBI, retail investors can participate in the first series through the non-competitive segment.

They have to indicate only the amount of their bids, and not the price at which they want to subscribe. They will receive allocations based on the price determined by institutional bidders.

Rajesh Iyer, Head- Investments & Family Office, Kotak Wealth Management, said " As of date, the challenge for an individual investor is that he is exposed more to Consumer Price Index (CPI) rather than Wholesale Price Index (WPI) hence inflation indexed bonds may not be a perfect hedge against inflation. For example as of date, WPI stands at 4.89% and CPI at 9.39% is showing large divergence. As per RBI circular, inflation indexed bonds would be taxed as per the current rules and no special concession will be provided for these bonds. Due to SLR status and low."

Secondly, as Firstpost said earlier , the tenure of the first IIBs are scheduled for subscription on 4 June. This means all through the life of the bonds, you may get measly yields - unless you choose to encash the bonds through a market sale, which will probably reflect in the price. It may be better to wait for short-term tenure bonds.