Inflation-indexed bonds

High and rising costs of living present a serious challenge to preserving the true value of your savings. As inflation increases, the purchasing power of money steadily declines, putting long-term financial goals at risk. In such conditions, inflation-indexed bonds serve as a crucial line of defence, helping you maintain stability and ensure your portfolios remain aligned with real-world economic pressures.

What are inflation-indexed bonds?

Inflation-indexed bonds are government-issued securities that protect investors against inflation by adjusting both the principal amount and interest payments according to changes in inflation rates. Also known as inflation-linked bonds or real return bonds, they differ fundamentally from conventional bonds, which pay fixed interest on a static principal amount.

Working of inflation-indexed bonds

• Initial investment: You buy the bond at a fixed principal value (say ₹1,000).
• Inflation adjustment: As inflation rises, the bond’s principal is adjusted upward based on the Consumer Price Index (CPI).
• Interest calculation: The interest (coupon) is paid on the adjusted principal, not the original amount, so you earn more when inflation is high.
• At maturity: You get back the inflation-adjusted principal, protecting your purchasing power.

Features of inflation-indexed bonds

• Inflation protection: Inflation bonds shield you from inflation's eroding effects. By adjusting the principal amount, these bonds ensure that your investment maintains its purchasing power over time.
• Flexibility: These bonds have flexible returns that are in line with the rates of inflation.
• Interest rate adjustment: The interest payments on these bonds adjust in response to inflation, typically by adding a fixed rate to the inflation rate.
• Benchmark: Inflation Bonds use the CPI as the benchmark for adjusting the principal amount and interest payments.
• Government Bonds: Most inflation-linked bonds are issued by the government as a means of raising capital while offering you protection against inflation.

Types of inflation-indexed bonds

While globally there are different inflation bonds, in India, they are primarily of two types:

Inflation Indexed National Savings Securities – Cumulative (IINSS-C):

• This is the primary inflation-linked bond offered by the government of India.
• The bond offers principal adjustment based on the CPI, meaning the value of your investment increases with inflation.
• The interest rate is applied to the inflation-adjusted principal, not the original amount, ensuring that your returns keep pace with rising prices.
• Interest payments are cumulative, meaning they are added to the principal and paid out at maturity.

Capital Indexed Bonds (CIBs):

• Issued by the RBI in 1997, but discontinued due to low investor interest.
• These bonds only adjusted the principal value for inflation, not the interest.

How to invest in inflation-indexed bonds?

Online

1. Log in to your Axis Bank Internet Banking.
2. Navigate to 'Investment' section for bond investments.
3. Select the inflation-indexed bond you wish to invest in.
4. Complete the application form for the bond purchase.
5. Upload scanned copies of your KYC documents (Aadhaar, PAN, etc.).
6. Pay via online transfer or other available payment options.
7. You will get an email or SMS confirmation with your bond details.

Offline

1. Go to your nearest branch or use online platforms if available.
2. Fill out the bond investment form at the branch.
3. Provide KYC documents such as Aadhaar, PAN, address proof, and photographs.
4. Pay through cheque, demand draft, or electronic transfer.
5. Axis Bank will provide a receipt and bond details.

Availability of inflation‑indexed bonds for retail investors in India is limited. When issued, they are generally available through authorised banks, RBI‑notified channels, or the primary market during specific government issuances. Investors should check with their bank or RBI notifications for current availability.

How is interest calculated on an inflation-indexed bond?

1. Determine the base principal.
2. Adjust for inflation: Increase the principal based on the CPI or inflation rate.
3. Apply the fixed real interest rate provided by the inflation bond.
4. Apply the fixed interest rate on the inflation-adjusted principal and calculate the interest.
5. The interest may be paid periodically or on a cumulative basis at maturity, depending on the bond structure.

Example:

• Base principal: ₹10,000
• Real interest rate: 2%
• CPI adjustment: Suppose CPI increases by 5% in one year.

Calculation:

• Adjusted principal = ₹10,000 × (1 + 5%) = ₹10,500
• Interest payment = ₹10,500 × 2% = ₹210

So, the interest you receive will be ₹210 instead of ₹200, as the principal was adjusted for inflation. This ensures the bond's value keeps up with rising prices.

Inflation-indexed bond benefits

• Continuous real returns: Inflation-linked bonds provide ongoing returns that maintain their purchasing power over time. These bonds deliver an income stream that adjusts with changes in the cost of living.
• Diversification: Including inflation-indexed bonds in an investment portfolio serves as an effective risk management strategy, particularly during inflationary times.
• Long-term consideration: For long-term financial goals like retirement planning, these bonds offer reliable protection against the gradual erosion of purchasing power, making them valuable components of a forward-looking investment strategy.

Conclusion

Inflation bonds represent a prudent investment choice if you are seeking to preserve wealth against inflation's eroding effects. By adjusting both principal and interest payments in line with inflation rates, these bonds ensure that you maintain your purchasing power regardless of economic conditions. While they typically offer lower yields than conventional bonds, their inflation protection feature helps during uncertain economic times.

Frequently Asked Questions

How to buy inflation-indexed bonds?

You can purchase inflation-indexed bonds through authorised banks, government websites, stockbrokers, mutual funds, or online investment platforms. Many banks offer these bonds as part of their investment products, and some provide digital platforms for convenient purchasing.

Are inflation-indexed bonds tax-free?

No, inflation-linked Bonds are not tax-free. Interest income and capital gains from these bonds are subject to taxation according to prevailing tax laws.

What are the disadvantages of inflation-linked bonds?

Inflation-indexed bonds offer lower yields compared to regular bonds. Their availability may be limited, and they carry market risk from interest rate fluctuations. Liquidity can be lower than with conventional bonds, and there's always the counterparty risk of issuer default.

Are inflation-indexed bonds a good investment?

Inflation-indexed bonds can be excellent investments for those prioritising capital preservation and inflation protection. They are particularly suitable for conservative investors and retirees living on fixed incomes.

Disclaimer: This article is intended solely for informational purposes. The views expressed in this article are personal. Axis Bank and/or the author shall not be liable for any direct or indirect loss or liability incurred by the reader arising from reliance on the content herein. Readers are advised to consult a qualified financial advisor before making any financial decisions. Axis Bank does not endorse or guarantee the accuracy of any third-party content or links included in this article.