Inflation-indexed bonds lose sheen

A year after bonds indexed to Consumer Price Index (CPI)-based inflation were introduced by the Reserve Bank of India (RBI), these have failed to find takers. The fact that inflation is on a downward trajectory has taken the sheen off such bonds further.

These bonds were launched to provide a hedge against rising inflation.

In November, CPI-based inflation fell to 4.38 per cent from 11.16 per cent in the corresponding month last year, the fourth consecutive monthly fall and the lowest since the government started releasing data on CPI-based inflation in February 2012.

Dwijendra Srivastava, chief investment officer (debt), Sundaram Mutual Fund, says when CPI-based inflation is falling, there is no reason for investors to lock their money in it, especially as other products such as Public Provident Fund were giving higher returns.

Also, in their current form, these bonds have several restrictions - these cannot be traded, there's a three-year lock-in period for those other than senior citizens, a minimum investment limit, etc. Also, as there aren't any distribution incentives and the bonds are available only to retail investors, demand for these bonds is likely to remain tepid.

"It is a complicated product, made accessible only to small investors. They should have opened it up to a wider range of investors, including high net-worth individuals and institutional investors such as (mutual funds) MFs, who have proved to be a good retail vehicle for investors. There has been a lot of interest from the MF community for inflation-indexed funds. MFs could have opened up for retail subscriptions," said R Sivakumar, head (fixed income and products), Axis Mutual Fund.

He added as an asset class, these bonds offered good diversification against nominal bonds. "When inflation rises, nominal bonds underperform and inflation-indexed bonds do well, and vice-versa. Therefore, it coexists very well with the existing bond portfolio."

Earlier, distributors and MFs had suggested revising this product, but a decision on this is yet to be taken.

The interest rate on these bonds comprise two parts - a fixed component (1.5 per cent a year) and the inflation rate, based on CPI, compounded on the principal on a half-yearly basis and paid at the time of maturity.

It has been suggested the rate of 1.5 per cent a year be increased, as CPI-based inflation is softening. It was also sought that tax incentives under section 80C be provided on this product.