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Business News/ Opinion / Six changes that will make the inflation-plus bond work

Six changes that will make the inflation-plus bond work

The bond issue has not been constructed keeping retail investors' needs and behaviours in mind

Shyamal Banerjee/MintPremium
Shyamal Banerjee/Mint

The life of a long-term investor seeking fixed returns is not easy. Unwilling to expose her money to the risk of the stock market either directly or through mutual funds, this investor finds her choice restricted to fixed deposits or insurance-linked investment products. Both of these are disastrous in terms of real returns, that is, inflation-adjusted returns. Bank fixed deposits today give 8.5-9.0% interest for a 5-year tenor. After accounting for consumer inflation of 10% and a tax of 30% on the interest, the real return is negative. Look at money-back or endowment policies that promise a tax-free return of 4% or 5%, the result is the same—you lose money to inflation by holding such products.

We must view low interest rates and tax benefits on products (small savings, insurance-linked investment products and provident fund money) as a strategy by governments to appropriate cheap funding. Called financial repression, this uses cheap retail funds to help reduce government debt. A lack of state-sponsored social security forces people in countries such as India and China to save large parts of their income towards any loss of income in the future and old age.

Lack of a market structure that builds trust in market-linked financial products forces investors to keep money in bank deposits or very low-value insurance-linked investment plans. You’d have thought that the government would have cracked down on products that return very little and yet not only charge high commissions but also mislead retail investors on expected returns. But it has not, and this seems to point towards financial repression as an unstated strategy.

We must view the ongoing issue of the Inflation Indexed National Savings Security–Cumulative (IINSS-C), or the inflation-plus bond, in this backdrop. Giving retail investors 1.5% over the Consumer Price Index (CPI) protects against inflation for sure, but the bond issue has not been constructed keeping retail investors’ needs and behaviours in mind.

Here are six things that the Reserve Bank of India (RBI) can do to make the bonds the next best thing after safety pins.

One, give a tax break on the interest. Insurance products that do little to provide effective risk cover get a full tax break on returns. The same should be extended to a superior product like the inflation-plus bond. In its current avatar, the inflation-plus bond is not attractive. The post-tax returns at every level of the CPI (combined) for the 30% tax slab investor is negative, though at CPI level of 5% and 6%, the post-tax return is almost nil, that is, the money does not lose value over time. For investors in the 20% tax slab, at all levels of inflation at 7% or beyond, the bond gives a negative return. For those in the 10% tax slab, the bond works at every level of inflation. Give a tax break and make this really something that people will line up to buy.

Two, instead of a 10-year lock-in period, allow the bonds to give annual interest. In fact, why not give a choice between 10-year lock-in and annual interest? An income-seeking retired investor cannot wait for 10 years for the fruits of this bond to come to her. She needs regular income and she is the biggest victim of soaring inflation. Allow her this super bond to protect against inflation each year.

Three, remove the 5 lakh per person limit on investment. If we take the 10-year lock-in as a given, then this is a product for the corpus-building, risk-averse investor. An amount like 5 lakh is small potatoes for urban investors; many of them have incomes that have grown along with inflation. Allow unlimited investment; if RBI sees unreasonable inflows from entities who want to convert black money to white, crack down on them. Don’t penalize the rest of us for what some system-gaming people may do.

Four, why have an offer period? Why can’t the bond be sold like a mutual fund, on tap?

Five, make the application process easier. You need two witnesses for people who cannot read and write to sign off on the form. Why?

Six, make the know-your-customer hoops wider. At present, investors need to have either an Aadhar number, or a driving licence or a passport to apply for the bond. But these people are most likely to have a bank account—why isn’t that good enough to apply for the bond?

The bond needs more work done on its structure, and the most difficult part of all—ease of access by retail investors.

Here’s hoping that 2014 will see this inflation-plus bond become the super bond we thought it would be.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor Mint Money, and Yale World Fellow 2011 and is on the board of FPSB India. She can be reached at

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Published: 25 Dec 2013, 06:40 PM IST
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