A New Product to Beat Inflation - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 6 April 2013
A New Product to Beat Inflation A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
The inflation rate in India currently stands just under 7%, and it moves around considerably. In the last year, it has been as high as 8%, and it was even higher before that. It is a fact of investing that we must bear inflation risk. Even when we put our money in a fixed deposit, we incur inflation risk.

For example, I could invest in a 1 year fixed deposit that earns an 8% return. I'm guaranteed to earn 8% on the cash I've deposited but I don't know what it will really be worth one year from now. If inflation turns out to be low (e.g. 6%), then I'll make a 2% real return. But if inflation turns out to be high (e.g. 10%), I'll end up with a 2% real loss!

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Is there any way we can avoid inflation risk? It turns out we will soon be able to do just that. This month, the Indian government is planning to issue inflation-indexed bonds for the first time. These will be available first to foreign institutional investors, and then domestic retail investors. How exactly does an inflation-indexed bond work?

If you hold one of these bonds, the return you earn depends on inflation. The principal value of the bond is periodically adjusted to account for inflation. Bondholders receive coupon payments and principal adjusted for inflation. In practice, this means the return you earn from holding the bond has no inflation risk.

When inflation goes up, the return on the bond goes up, and when inflation goes down the bond return goes down. This is done in such a way that the real return (nominal return minus inflation) is constant. For example, you could invest in an inflation-indexed bond that earns a real return of 2% in a year. This means that the return you get is 2% above inflation in any given year.

Inflation-indexed bonds are common in the US and many European countries, and they will soon be a part of Indian markets. By investing in inflation-indexed bonds, one can avoid the inflation risk usually associated with common fixed deposits. The introduction of inflation-indexed bonds represents a positive development for the Indian financial markets and for investors.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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8 Responses to "A New Product to Beat Inflation"


Apr 28, 2013

To be precise current retail inflation is 15%. As a retail investor it is safe to not be invested in this bond index product. in a developing country like India at least for a decade or so from now as inflation will be above double digits.
As one invests in such products when this is introduced he/she will for sure gets into phony trap of supporting govt figures as he is now has to be on their side.
And remember risk is high once your total overall investment goes above one lakh as govt do not secure the amount above it for ex in USA it will secure upto 26 times your debt investment (written on paper).

Like (1)

Pramod Phadke

Apr 8, 2013

Most important point is who decides inflation rate? Obviously, Government! I don't trust Govt to post true figures. When Govt says the inflation is 8%, it could very well be as high as 15%.
For example, take cost inflation index used for computing capital gains. The Govt declared index is so low that you invariably end up paying much more tax than you should, if evaluated fairly.
Even the index used for payment of dearness allowance is grossly underestimated.
In short, the Govt has lost trust of people like me. The proposed bond is not for me, sir!

Like (1)


Apr 8, 2013

Inflation Indexed Bonds.......

What about Tax on the interest/coupon payments?...

Like (1)


Apr 7, 2013

It is a good move from Government especially for retirees who can plan their post employment life. In order to compare the product, what are the currently available products based on the past historical data? This information will be very helpful.
Thank you

Like (1)

Ragini Ghanekar

Apr 7, 2013

Which inflation index will be used for these bonds? wholesale or consumer price index. Will it make any difference?

Like (1)

Abhaya Kumar

Apr 7, 2013

Being such a good analyst, how can u
Ignore the fact that the governments mode of inflation calculation and the actual inflation
Are far away from reality.
It's just another mockery on the indian investor ,
To quote with proper example
Considering 8 percent inflation for last 5 years ,rs 1 lac should be equally worth
One lak and forty thousands; but in reality the purchasing power of
One lak can't even be satisfied with 2 laks today
Be it education , food, hotels, basic necessities , travel and the huge list goes on!!!

Like (1)

Stupid Investor

Apr 7, 2013

How will inflation be measured, and by whom ?
Core inflation ?
Or including food & energy ?

Who will measure the inflation ?
A govt. agency ?
or an independent agency ?

Like (1)


Apr 7, 2013

Someone is taking the inflation risk and in this case its going to be the banks. As far as the banks portfolio of such bonds is small, that's fine, but if it becomes big and in case inflation is high, we will have doubts about the banks ability to honour its commitments and shareholders should run. Remember the FCCB problem being faced by so many companies.

Like (1)
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