What are inflation indexed bonds?

In a move to wean away households from either buying or investing in gold, Finance Minister P Chidambaram in the Union Budget 2013 announced the launch of an inflation indexed bonds or inflation-indexed National Security Certificates.

In case of inflation indexed bonds, the coupon rate is likely to be linked to inflation and would move in tandem with inflation, while the principal would remain steady.

Why is it necessary?

If inflation is higher then the interest rates in the economy the real rate of returns turn negative, which is why investor prefer to invest in gold and real estate.

By launching the inflation indexed bonds, P Chidambaram plans to wean away investors from gold and real estate.

Chidambaram said that consultations will be held with the Reserve Bank of India and details of the instruments will be announced in due course. "The private sector, comprising households and corporates, remains the main contributor to saving. The household sector must be incentivised to save in financial instruments rather, than buy gold," he said.

Inflation indexed bonds are a perfect hedge against gold, since gold has served as a hedge against inflation. But, the question is given India's penchant for gold, will the index inflation bonds work? It's difficult to say unless details of the scheme are announced. If the government provides some kind of incentive like a tax rebate, it could very well work or else individuals would prefer gold.

In any case, one will have to wait for the details of the scheme before one can draw a conclusion.

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