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Protect Your Investments from Inflation

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Inflation-indexed bonds, offering 1.5% above consumer inflation, will work well for those whose income is not subject to tax or who fall in the 10% tax bracket

Earning 1% above inflation is the ultimate dream of many conservative investors, who mostly invest their money in secure bank and company deposits. These investors will soon have an investment option that will help them beat inflation easily.

The Reserve Bank of India had announced last week that Inflation-Indexed National Savings Securities (IINSS-C), linked to Consumer Price Index (CPI), will be launched in the second half of December. IINSS-C is in line with the announcement made in the Union budget this year to introduce instruments that will protect savings from inflation.


Since the interest payout is linked to CPI, IINSS-C helps you stay ahead of inflation as you earn 1.5% above inflation. Interest rate on IINSS-C comprises two parts — fixed rate (1.5%) and inflation rate based on CPI. Both these will be added, compounded in the principal on a half-yearly basis and paid on maturity.


Since the interest income is variable, IINSS-C cannot be used to plan for your goals as there is no certainty of what you will get on maturity. These bonds are unattractive to those in the higher tax bracket as post-tax returns are lower.


IINSS-C will have a tenure of 10 years, a face value of Rs 5,000 (you can buy one bond) and will have an upper limit of Rs 5 lakh on investment by individuals. Assume you make an investment of Rs 1 lakh. If the CPI is 10%, your return will be 11.5% (10% plus 1.5%). The interest will be compounded half yearly. So after six months, you will earn . 5,750 as interest income. If CPI inflation rises to 10.5%, you will get a 12% return in the second half. Or in other words, you would earn an interest income of Rs 6,345. The cnumulative value of your . 1-lakh investment at the end of any year will be Rs 1,12,095, giving you a return of 11.21%. With CPI currently hovering around 10.09%, these bonds could give you better returns than a bank fixed deposit that gives you around 9.0-9.5%.


While bank returns are fixed on the date you invest in till maturity, the returns from IINSS-C could go up or down during the tenure, in line with changes in inflation. However, unlike the bank deposit, the cumulative value of your investment in IINSS-C on maturity is unpredictable.


Though these bonds will help you beat the official rate of inflation, they are not very tax efficient for those in the higher income tax slabs. For example, if you earn 11.21% as shown in the earlier example, your post-tax return would be only around 7.74% if you are in the 30% tax bracket.
However, if you fall in the 10% tax bracket, your post-tax returns will work out to be 10.05%. That is why many investment experts believe that these bonds will be more suitable for those in the lower tax bracket or not liable to pay taxes. Taxfree bonds will be better suited for those in the higher tax slabs. Tax-free bonds available from IIFCL offer you 8.66% for a 10-year tenure.


Compared to bank deposits, IINSS-C scores low on liquidity. If you need money urgently, you can walk into your bank branch and break the fixed deposit immediately. According to the Reserve Bank of India circular, IINSS-C has a tenure of 10 years, with an option for early redemption after one year from the date of issue for senior citizens (above 65 years of age) and three years for all other investors, subject to penalty charges at the rate of 50% of the last coupon payable for early redemption. That is why many experts advise investors to invest in IINSS-C only if they intend to hold on to their investment until maturity.


Bond Relief


The Reserve Bank of India had announced last week that Inflation-Indexed National Savings Securities (IINSS-C), linked to Consumer Price Index (CPI), will be launched in the second half of December Interest rate on IINSS-C comprises two parts — fixed rate (1.5%) and inflation rate based on CPI. Both these will be added, compounded in the principal on a half-yearly basis


and paid on maturity INSS-C will have a tenure of 10 years, a face value of 5,000 (you can buy one bond) and will have an upper limit of 5 lakh on investment by individuals


While bank returns are fixed on the date you invest in till maturity, the returns from IINSS-C could go up or down during the tenure, in line with changes in inflation

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