RBI has finally fulfilled its commitment and Inflation Indexed National Savings Securities-Cumulative are being issued from today. Opened till December 31st,2013 the objective of these securities is to provide investors much respite from high inflation. These securities are for a long term horizon and only for retail investors. But before you take any decision it’s wiser to analyze them and see where they will fit into your investment basket.
Here is a brief review of the Inflation Indexed National Savings Securities-
What are Inflation Indexed Securities?
Before we look into RBI securities, lets understand the Inflation Indexed Securities. These are specifically designed to guarantee a higher return than inflation if they are held to maturity. In these securities the principal or coupon is linked to inflation rates and vary as the inflation rises or falls. Since these are safer instruments, considering the sovereign guarantee they carry, they are most appealing to investors who look for safer returns but higher than inflation. In simple words these securities offer higher real returns which make them attractive. They might come in different forms where some may be traded for capital gains while some may not. Overall, an inflation Linked Security is a high attraction for retail investors.
What is IINSS-C?
In line with the above objective, RBI has launched Inflation Indexed Savings Securities from today. These securities will be for a fixed term of 10 years where it will pay a fixed coupon to the investors. On completion of the term the principal amount will be paid to the investors along with accrued interest. Any individual, Hindu Undivided Family, Charitable Institutions registered under section 25 of the Indian Companies Act and Universities incorporated by Central, State or Provincial Act or declared to be a university under section 3 of the University Grants Commission Act, 1956 (3 of 1956) is eligible to invest in the securities. But NRIs are not allowed to invest. The minimum amount for investment is fixed at R 5000 while the maximum has been capped at R 500000 per individual in a financial year. The face value of the bond is kept at R 5000 and one can apply in multiples of the same.
Unlike inflation indexed bonds issued earlier where the interest rates was linked to Wholesale Price Inflation (WPI), the interest rate in these securities is linked to Consumer Price Inflation i.e. CPI, which is a more reflection of our daily household inflation. Here, the interest rate comprises two parts, the inflation rate and a fixed rate (1.5% per annum) as mark up over and above inflation. But instead of simple interest rate, the rates in these securities will be compounded in the principal on half-yearly basis and is payable only on maturity.
How Inflation Rate will be derived- (Interest rate on these securities would be linked to final combined Consumer Price Index [CPI (Base: 2010=100)].To calculate this inflation rate – The final combined CPI will be used with a lag of three months, i.e., final combined CPI for September 2013 will be used as reference CPI for all days of December 2013).
So, in summary, it’s the interest which will be linked to inflation and adjusted accordingly. If inflation remains high the interest on these securities will be higher and vice versa.
The IINSS-C have an option of premature redemption. Senior citizens can do it after one year and rest of the investors after 3 years from the date of issue. However, a penalty of 50% of the last coupon paid will be levied for this. These securities cannot be transferred to any other individual during his/her living. But it has a nomination facility who be entitled to receive the money on death of the holder of securities. These can also be kept as collateral for availing loans from banks, financial institutions or NBFC.
Taxation is one of the most important aspect in any fixed income security since it reduces the net returns. In IINSS-C the interest is fully taxable as per your income tax slab and that too on accrual basis. So every year the interest will be added to your investment and you will have to pay tax on it.
Should You Invest
Inflation is a huge dampener for our savings or investments and that’s the reason why we eagerly look for any instrument which can beat inflation and give us higher real returns for our goals accumulation. It is a golden investment when such instruments can guarantee this. But unfortunately IINSS-C fall short on many aspects and so get restricted to only few category of investors-
1. Liquidity- In any long term investment liquidity also plays an important role. Although these securities offers a premature redemption, you have to pay a penalty on it. Otherwise there is no liquidity available to investors as these will not get listed much unlike IIB issued earlier which are listed now.
2. Taxation- The biggest disadvantage of these securities is that the interest is fully taxable and that too on accrual basis i.e. you have to pay tax every year as the interest is accrued and not on maturity when you finally received it. Over and above this they will not be carrying any indexation benefit since the document release by RBI do not mention it. Absence of all such benefits reduces the returns from these bonds post taxation.
3. No Recurring Income- Another dampener in these securities is that the interest is only cumulative which means there is no benefit for any individual seeking a regular income. So for post retirees these securities are not favorable at all and that’s a big disappointment for them.
4. The Real Returns- Although the interest rate has been linked to the consumer price inflation the taxability is surely not in favor for most investors. Even a 11% return boils down to 7-7.5% for anyone in the highest tax slab.
Here is what you earn at different tax slab:
If you look at the above calculation then the net returns is considerable only for individuals in the lower tax slab. In highest tax slab the net returns post inflation are not favorable for investment.
5. Better Alternatives- When you compare these bonds with PPF or even tax free bonds then they prove to be a better alternative. The tax free bonds attraction is the fixed interest throughout the term for all categories of investors and a recurring payout option makes it reachable to more investors. Contrary to this the return from IINSS-C will decrease as the inflation falls going ahead.
With all the factors discussed above, IINSSC may find only few takers who are in lower tax slab. But for other categories the alternatives available are much wiser. It would have been more lucrative if these securities would have been given some benefits in taxation and more option of interest payout. Still if one would like to go because of sovereign guarantee, ensure you know what will be the actual earning for you.