Inflation-indexed Bonds will Protect Savings and Lower the Demand for Gold

However, it lowers the country’s financial savings and also widens the current account deficit. The need is for a financial instrument that would protect the capital invested against erosion by inflation and also offer a positive real rate of interest. With consumer price inflation over 10%, practically no fixed-income option offers an investor a positive real rate of interest, the nominal rate less the rate of inflation. True, there were hardly any takers for similar bonds in the 1990s.

However, the poor demand was due to flaws in the design: only principal repayments at the time of redemption were indexed to inflation. RBI now proposes to redesign the scheme, indexing both the principal and the coupon to the inflation rate. This makes eminent sense. It means the payout will increase when prices rise and vice versa, thereby ensuring that the purchasing power of an investor’s earnings remains intact. IIBs would help investors diversify their asset portfolio and also ensure investment in more productive assets.

These bonds can also be a huge draw for pension, insurance and other institutional investors. This should dampen the demand for gold to an extent. We also need to make our financial markets more attractive to investors. One, the government should take steps to develop a well-functioning corporate bond market that allows appropriate risk-return pricing and more access to credit. Two, regulators must ensure that financial products are simple, easy to understand and supported by stable incentives.

Three, it is also imperative for the government to incentivise distributors of products such as the National Pension System (NPS) that has the institutional framework to generate superior returns on old-age savings. Subscribers of the Employees’ Provident Fund Organisation must be allowed to voluntarily migrate to the NPS. It will create a larger pool of funds that can be invested across asset classes.