CPI linked IINSS - not attractive at all

CPI linked securities were touted by RBI and Finance ministry to be the main answer to counter the ‘menace’ of gold buying by Indian citizens. Here is how the new product offered by RBI stacks up against the yellow metal.

Investible Limit

IINSS: Minimum lot size is INR 5000 and maximum is INR 5 lacs per annum. The upper cap on the investment baffles me.

Gold or Gold ETF: Minimum lot size is 1 unit of the ETF which typically is 1 gram equivalent. Maximum is generally not capped unless some AMC suddenly acts to be patriotic and limit future investment in the ETF.

Result: Gold is better than IINSS as there are no restrictions on the minimum or maximum lot sizes.

Lock-in and Liquidity

IINSS: 3 years for general public and that too after a penalty of 50% of last coupon – additionally can be done only on the coupon date.  Even the WPI linked bonds are much saner in this aspect as they allow selling any time post the purchase.

Gold: No Lock-in whatsoever.

Result: Gold is better than IINSS as there is practically no lock-in and liquidity is proven.

Tax Treatment

This is the most crucial aspect which totally baffles me as to what the IINSS product designers were thinking.

IINSS: The coupon is fully taxed at the investor’s marginal tax rate. As per the specification of this product, the interest is accrued semiannually but paid out at the maturity after 10 years.  But the investor has to show the interest each year and provide for tax. The retail investor can’t arrive at the coupon received on checking his bank statements and pay tax, but has to ‘compute’ the interest earned using an Index which the RBI itself has declared to be not yet stable. The investor has to compute interest on a complex index, calculate tax (no TDS) based on his marginal income tax rate and pay income tax on an interest payment he has not received - not going to receive in the next 10 years.  The net negative cash flows owing tax payments can easily outdo the 1.5% yield premium provided. Outrageously bad.

Gold: The investor can ‘generate’ a coupon by selling the units of ETF. Short term capital gains tax are the investor’s marginal tax rate – effectively same as IINSS. Long term capital gains tax (>1 year) is after application of indexation benefits: 10% without indexation and 20% with indexation. The best part is the indexation itself is based on CPI.

Result: IINSS is particularly worse in this regard with the issuer (who is also the tax collector) having the cake and eating it too. IINSS is probably the only financial product in the country which has a lock-in period without any tax benefit either at investment or at income stage.

Overall Verdict: If you are patriotic and want to donate money for the nation’s welfare, IINSS would be more profitable than giving money directly to PM fund. The main declared objective of IINSS was to shift investments from gold to IINSS – I expect that wont happen one bit.

On a serious note, IINSS is definitely inferior to Gold ETF on a variety of factors as listed above – only solace for IINSS is it can’t have negative return while Gold can have negative returns – that is true for any fixed income investment vs risk asset investment; even tax free bonds issued by PSU companies offer more value than IINSS; WPI linked bonds offer better value than even tax free bonds because of the low coupon and better effective tax treatment; easiest of all – even debt mutual funds offer more value than IINSS because of the tax angle.The only product that IINSS can possibly beat is bank fixed deposits - even FDs have some tax benefits when booked for 5 year tenure.

Bottomline: I will stick to WPI linked bonds than to invest in IINSS if I want to be anchored to a local inflation index.


Suggestions to RBI/Government of India: 
A flat income tax rate of 10% on the coupon + option of taking out coupons semiannually could make the product sufficiently attractive.