Inflation indexed bonds (IIB)

Economy and Finance

Inflation indexed bonds (IIB)

05 Jul 2023 Zinkpot 207

Inflation indexed bonds (IIB) is a bond issued by the Reserve Bank of India that guarantees a fixed yield regardless of the level of inflation in the economy, It protects investors from macroeconomic risks in the country.
Inflation is bad for investments. High inflation eats into the profits, which reduces the actual return. IIBs help protect investors’ wealth from the negative impacts of inflation.
With conventional bonds, investors get a fixed interest rate and receive regular interest payments, which are also known as coupon payments. But these are not adjusted for inflation.
To illustrate, let’s say a one-year bond of INR 10,000 was purchased in January with a fixed interest rate of 1.5%. At the end of the year, INR 10,150 will be received. But this value of the return would not depend on the annual inflation which if risen would have reduced the purchasing power of the currency, causing loss to the investor.
Under inflation index bonds, the principal is regularly adjusted for inflation and the fixed interest rate is applied to the adjusted principal.
For example, if the annual coupon is 8 per cent and the principal is Rs 100, the investor will be paid Rs 8 a year. If the inflation index rises 10 per cent, the principal will become Rs 110. The coupon will remain 8 per cent, resulting in an interest payment of Rs 110 x 8 per cent = Rs 8.8.
These bonds can be used to diversify and stabilise the portfolio. This is because their principal rises with inflation. But when inflation fall, the principle does not go below the issue amount.
These bonds are in reference to a market index that measures inflation like CPI.
The main aim of the government in issuing these bonds is to target people who invest in gold to hedge their portfolios from inflation.