INFLATION INDEXED BONDS FAIL - PRICELESS TO LESS

By Ruma Dubey

Last June, RBI had re-launched Inflation Indexed Bonds (IIBs). And this June, the very same bonds have been removed from the markets. Reason – the response was very poor.

Sometimes, you wonder at how things work – the product is excellent, the target audience is in abundance and it gives the best and most secure returns. It was an instrument designed to give you returns in tandem with the existing inflation. And with RBI taking the guarantee, what could have been more secure?

But unfortunately, it failed miserably. This was on mainly on due the failure of the two P’s. There are three P’s of marketing – product, price and promotion. The RBI had an excellent product but pathetic pricing and promotion was non-existent.

First pricing. The pricing was good – if the inflation was 9%, the interest rate on the bonds would be 1.5% higher. That’s very good. But what was bad was the taxation angle. The interest earned on these bonds was treated like income and this meant it attracted a 30% tax. This is unlike mutual funds offering bonds, which after one year, attracted long term capital gains tax of 10 to 20%. Thus people naturally preferred these other bonds on offer as ultimately after the 30% tax, the returns on these IIBs did not work out to any advantage.

Second, the promotion. The RBI undertook no marketing of the bonds. It probably felt that the product itself was so good, it will sell by itself. But the problem was that people did not know IIBs were on offer and if they knew, they did not know where to go and buy them. The IIBs were sold through select outlets of SBI, HDFC Bank, ICICI Bank, and Axis Bank. But how many knew this?

Many say that the timing of the bonds were wrong. How can that be as inflation has always been high; so in India, unless inflation fall below 6%, timing could have never been wrong? There were many who felt that the structure of the IIBs was complex and many did not even understand how these IIBs worked. So even here, the RBI failed to educate the people and that is also attributed as one of the causes of failure of IIBs.

Thus a good product but marketed poorly did it in. It’s a pity because these IIBs were re-launched or rather re-re-launched!  Previously, rather half-heartedly, RBI had launched IIBs. First time was way back in 1997 where only the principal was indexed and not the interest rate. This was withdrawn and a new version was once again launched in 2004 and this time, both principal as well as interest rate were indexed. The IIBs failed because there was no faith in the benchmark and there was no real depth in the bond market. But this time around, the benchmark, the way WPI was calculated and the depth in the bond market, all had improved. Yet, it failed to take off.

RBI is now planning to work on these IIBs again, improve certain features and once again try and make it attractive for the investors. There is talk of RBI considering various options like increasing the spread, maybe go for a non-cumulative option and is also considering offering a quarterly interest payout.

There is no doubt that IIBs make a lot of sense. More importantly, there is mindless investment in gold and realty at illogically high prices. IIBs make perfect sense as it is the perfect hedge against inflation. It will help investors have a more diversified asset portfolio and give them more productive assets. Hope RBI gets it right this time around!