Tuesday, August 27, 2013

Inflation Indexed Bonds better than Tax Free Bonds

10Y inflation indexed bond issued by Government of India is giving a real yield of 3.47% - at WPI expectation of 6% it gives an IRR of 9.96% which is significantly better than the IRR of 8.70% for 7.16% 2023 bond which is the current 10Y.  The IRR of the bond at various WPI expectations are as per the following table:

Average WPI expectation for next 10Y
IRR of the 10Y Inflation Linker at CMP

The key item of note in this case is the low coupons of the bond – it can be considered a zero coupon bond with little reinvestment risk; add to that the long term capital gains on maturity will have indexation benefit as well and hence materially tax efficient. 

To summarize, Inflation Indexed Bonds:

  •  Have Less Reinvestment Risk
  • Are a good hedge against WPI increases, especially in a period when imported inflation is a genuine reality
  • Have Low Coupons meaning lower tax on coupons (slightly redundant to cite, I agree)
  • Are Tax efficient on capital gains as Indexation benefits get applied

Leave all the tax free bonds and buy this sovereign rated Inflation Linker.

Good way to buy GSec for Retail investors who do not hold CSGL accounts IDBI Samriddhi Portal

Update: I have made this post sometime in August and now Foreign institutions are queueing up in advising institutional clients to get into IIBs. Please find the link here of the report from Barclays.

Why WPI IIB is better than CPI IINSS?
Indexation benefits of WPI IIB 

1 comment:

Alicelee said...

Mind blowing blog..
Where you can get many details about the tax and inflation..very great to see this..
Thanks for sharing..