Monday, June 10, 2013

Can Inflation Index Bonds replace gold as a safe investment....???

India is the world's largest consumer of gold, accounting for some 20 percent of the world's demand.
In India gold is historically and culturally tied to the concepts of wealth and prosperity. The demand for gold has been increasing drastically in India which lead to a current account deficit of 4.3%.  Govt tried to reduce the import of Gold by imposing 75% import duty. But still the demand for gold is not reducing, so to curb this demand the govt introduced Inflation Index Bonds in this year's Union Budget. Inflation Index Bonds have been recommended in the Economic Survey Report of 2013. RBI soon going to issue the IIB''s on 4th June 2013 to protect the savings against the rising prices.

The reason why these bonds are launched because Inflation erodes the purchasing power of money and people are investing in gold as a hedge against inflation. The advantage of IIB is that adjusts its interest payments depending on the inflation rate. As the inflation rate changes every year, so does the cash flow from the IIB. The other advantage of the IIB is that it not only adjusts the interest payments to inflation but also the principal repaid to the investor at the end of the bond's tenure.

Although inflation-indexed bonds prove beneficial during times of high inflation, they underperform when the economy goes through a deflationary phase and prices actually come down. So it cannot be said that the IIB's will replace the gold as a safe investment and another  big drawback of these bonds is that they have been indexed to the WPI and not the Consumer Price Index (CPI). For most investors in bonds, the CPI is the more relevant index. Consumer prices matter to them in day-today life than wholesale prices. Above that the Indians has been attached to gold as it is used as a traditional jewellery for all the festivals and occasions in India. Even after the fall in gold prices recent Akshaya thrithiya Festival boosted the demand for gold. In a country like India it is believed that if the gold is bought during Akshaya thrithiya or Dhantheyras the whole year will bring financial prosperity. These festivals creates a key gold buying occasion in India and the consumers are obsessed especially the women consumers ,so the obsession will bring the market for Gold in India. So let's wait and see whether the IIB's will replace the gold or not??
 By Sneha Baby, Intern at CPPR