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Business News/ Money / Calculators/  Pegging inflation-indexed bonds to WPI gives half protection
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Pegging inflation-indexed bonds to WPI gives half protection

What affects us is the prices we pay in the market and this is reflected in the CPI data.

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To protect your investments from eroding due to the threat of inflation the government is set to launch a new investment tool called the inflation-indexed bonds. On their show, Smart Money; Vivek Law, editor, Bloomberg TV India and Monika Halan, editor, Mint Money, help you in understanding this product better. Edited excerpts:

Vivek: Monika, I remember when the announcement regarding these bonds was made we discussed about it on this show. You did say that as a concept it’s very good. As of now, we have some clarity on the way these could be structured eventually. So, do you hold the same view that these would be successful instruments and people should consider them?

Monika: We will have to wait for the exact rate to be announced. But let’s just pull back a bit and understand why these bonds are in the market. From the point of view of demand, people want something which will provide a hedge against inflation in the long-term. And from the supplier’s side let’s understand what the government wants. They are extremely worried about the increasing use of gold as a hedge against inflation.

So, now let us look at the bond itself. We have a 10-year bond which we will get in the market; both the principal as well as the interest is going to be protected against inflation. Let’s assume that inflation grows at 6% year-on-year every year for 10 years. So hypothetically then 1 crore will become 1.8 crore. At 7% inflation, 1 crore becomes almost 2 crore in terms of the principal that you get back. So that’s what happens if the rate of inflation is progressive every year.

In terms of a concept, the bond is very good. But let’s look at the pros and cons. We like the fact that both the principal and interest are inflation-indexed. Also, the fact that the interest is paid out twice a year and the principal is protected in the unlikely event of deflation. What all of us dislike is the fact that they pegged it to something called the Wholesale Price Index (WPI). There are two inflation measuring tools in the market which are the WPI and the Consumer Price Index (CPI).

What affects us is the prices we pay in the market and this is reflected in the CPI data. And at the moment, the difference between the WPI and CPI is a good 4-5 percentage points. By pegging it at the wholesale level, I think it doesn’t really give you the comfort in terms of protecting your money against inflation the whole way. It gives us only half the protection.

Vivek: So what would your suggestions be to the government? Also if we are going to be talking about people choosing between inflation-indexed bonds and gold, what would be the one or two features that you would like to see in this product once it is out there in the market?

Monika: Link it to CPI. The problem is that the way the CPI is measured. From the government’s point of view they are saying they have only 13 data points. It began in 2011 and so they are saying that they don’t have the data. But fix it and give us real hedge against inflation.

And the second thing is that it takes very little effort to buy gold. You can go to the local jeweller, or to your bank and walk away with gold. But for these bonds you have got to open an account; you have to find out who the primary dealers are.

Now there is a retail issue expected in October; we will have to wait and watch to see how it works. But you will need to make it easily available either through banks or through distributors so that it comes into the radar of retail investors and they find it easy to buy these bonds.

Vivek: Kashif Khan, a 32-year old, has sent us an SMS from Karnataka. He wants to know for a cover of 1 crore and a 30-year tenor, which term cover should he opt for.

Monika: It’s a question we get again and again. Here is the process in short: go online and buy the cover. If you are buying a term cover you get it about half as much expensive as a normal agent-sold policy.

Compare the prices. Since you are also looking at a long tenor of the policy, buy the maximum cover that you can get in terms of tenor.

So whether it’s 25 or 30 years, it’s an annual contract, you can terminate it the day you don’t need a life cover. Also remember that there is something called the settlement record of a company. There are nine companies in the market who have a settlement record of more than 90%. Which means that 90 out of 100 claims that they get, they settle.

Vivek: Alright, let’s also have a quick look at the insurance companies which have more than 90% settlement record.

Voice-over: Nine insurance companies in FY13 have settled more than 90% of their claims. These insurers include Life Insurance Corp. of India Ltd. ICICI Prudential Life Insurance Co. Ltd has a settlement record of 97%. ICICI Prudential is followed by HDFC Standard Life Insurance Co. Ltd with 96% of claims settled.

Vivek: Aditya has sent us an e-mail. He says that he is paying high taxes as he hasn’t invested in any tax-saving instruments. So Monika, as a beginner what kind of tax instruments should Aditya look at?

Monika: Rules remain the same for everybody. First, of course, you need to start at the beginning of the year and not wait till February to begin your tax-saving investments. So Aditya is fairly well off the mark.

Secondly, you make a list of the products that you already have. Next, if you have a term insurance policy or you have a life insurance policy, its premium is also a part of the section 80C basket of products. Then you should open a Public Provident Fund (PPF) account. You can invest up to 1 lakh in PPF. If there is nothing else before that, you can actually put the entire 1 lakh in to PPF. Additionally if you have mediclaim of up to 15,000 a year in addition to the 1 lakh of 80C, you can claim that as a deduction.

Vivek: Let’s also quickly tell you what are these products from the 80C basket which offer tax benefits.

Voice-over: The section 80C basket for income tax benefit includes contribution to Employees’ Provident Fund, PPF, investments made in to National Savings Certificate and premiums of life insurance. Repayment of housing loan principal and investment in equity-linked saving schemes of mutual funds also gives tax benefits. Fixed deposit with banks having a lock-in period of five years, Senior Citizens Saving Scheme and pension funds are also a part of this 80C basket.

Write to mintmoney@livemint.com OR sms at 9773270010. Type SM, give a space, and write your query.

Catch the show on Friday: 08:30pm, Saturday: 06:00pm, 08:30pm, Sunday: 10:00am, 12:30pm and 05:30pm on Bloomberg TV India.

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Published: 04 Jun 2013, 07:30 PM IST
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