With reference to the Indian economy, what are the advantages of “Inflation-Indexed Bonds (IIBs)”?

1. Government can reduce the coupon rates on its borrowing by way of IIBs.
2. IIBS provide protection to the investors from uncertainty regarding inflation.
3. The interest received as well as capital gains on IIBs are not taxable.

Which of the statements given above are correct?

[UPSC Civil Services Exam – 2022 Prelims]

(a) 1 and 2 only

(b) 2 and 3 only

(c) 1 and 3 only

(d) 1, 2 and 3

Answer: (a)        

Explanation:

• Inflation-Indexed Bonds (IIBs) offer investors a continuous return that is adjusted for inflation, providing protection against inflation. Statement 2 is correct.
• The real coupon interest rate on IIBs is fixed, but the nominal principal value is adjusted for inflation.
• As a result, the government can reduce the coupon rates on its borrowing through IIBs. Statement 1 is correct.
• Periodic coupon payments are made based on the modified principal value, protecting both the principal and coupon payments from inflation.
• When the bond matures, the adjusted principal or face value, whichever is greater, is paid.
• IIBs are classified as government securities (G-Sec) and are eligible for repo transactions and SLR status.
• By protecting the principal amount against inflation, IIBs make it easier for small investors to invest and earn returns based on the current inflation rate, while also helping to increase domestic savings and reverse the trend of declining savings-to-GDP ratios.
• These bonds can be traded in the secondary market (through the BSE, NSE, and other stock exchanges), however, if they are sold in the secondary market and profit is made, capital gains tax is to be paid. Hence, Statement 3 is not correct.