The finance ministry and the Reserve Bank of India (RBI) are concerned that the price discovery of inflation-indexed instruments for retail investors could be difficult. Hence, it will be tested with primary dealers, to arrive at a market-determined price.
“There are two views on whether the coupon rate on these bonds would be less than inflation or more. Some people say it will be definitely minus inflation. It is good for the government if the spread is negative, but then you can’t attract investors,” said a finance ministry official.
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The bonds, to be linked to the wholesale price index (WPI), might have a maturity of 10 years, with a call and put option of five to six years. Thus, investors will be able to redeem the bond after five or six years.
The inflation-indexed bonds may be offered to investors only once a month and may not come up in every auction by the government. The size of each issue is not likely to be less than Rs 2,000 crore and the government may mop up overall Rs 20,000 crore from these debt instruments.
In Budget 2013-14, Finance Minister P Chidambaram had announced inflation-indexed bonds or inflation-indexed National Security Certificates to protect the savings of the poor and middle class from inflation and offer an alternative to investment in non-productive assets such as gold.
Officials clarified that inflation-indexed National Security Certificates would be primarily for retail investors, while inflation-indexed bonds were mainly be targeted at institutional investors. While these bonds will be traded in the security market, investments in the certificates are likely to be treated as liquid assets under Statutory Liquidity Ratio requirements for banks.
RBI may soon announce the structure and tenor of these instruments and the auction for institutional investors may be conducted as early as next month.
“The bonds may have a maturity of 10 years to begin with, but later the government can look at bonds with a maturity of 19 years as the life insurance sector looks at that category,” said another official.
The bonds, which will protect both the principal and the interest components from inflation risks, may have a fixed coupon rate and a spread (plus or minus), depending on the bids. Inflation can be taken annualised or as on date. The view so far is that the latter is more transparent and market- linked.
The interest rate will be calculated on the principal amount, which has been adjusted to inflation. For instance, if a simple bond of Rs 1,000 is issued at a coupon rate of eight per cent, the subscriber will get Rs 80 as interest at the end of the year. If inflation increases to nine per cent, the principal amount in the case of inflation-indexed bond will be adjusted to Rs 1,090. Subsequently, the interest payment will go up.
Inflation-indexed bonds have been a success in developed markets such as the US, the UK, Canada and New Zealand. In India, the government tried to experiment with such bonds in 1997 and 2004, too, but without much success. If inflation is stable or lower, people usually don’t subscribe to such bonds. WPI inflation fell to 5.96 per cent in March from 6.84 per cent in February.
HEDGE DEVICE
- Coupon rate may be lower than inflation
- Bond may have maturity of 10 years
- Call and put option of 5 to 6 years likely
- Not more than one issue in a month
- Size of each issue may be at least Rs 2,000 crore
- To protect both principal & interest from risk