[Solved] With reference to the Indian economy, what are the advantages of “Inflation-indexed Bonds (IIBs)”? Government can reduce the coupon rates on its borrowing by way of IIBs. IIBs provide protection to the investors from uncertainty regarding inflation. The interest received as well as capital gains on IIBs are not taxable.

Q5) With reference to the Indian economy, what are the advantages of “Inflation-indexed Bonds (IIBs)”?

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

Which of the statements given above are correct?

Answer: a

Inflation Indexed Bond (IIB) is a bond issued by the Sovereign, which provides the investor a constant return irrespective of the level of inflation in the economy.
The main objective of Inflation Indexed Bonds is to provide a hedge and to safeguard the investor against macroeconomic risks in an economy.
IIB are compared with the instrument of fixed deposits with the bank.
While fixed deposit offers a fixed rate of interest for the investment for a given number of years, it does not protect the investor from the erosion of real value of the deposit due to inflation.
IIB on the other hand, gives a constant minimum real return irrespective of inflation level in the economy.
Capital increases with the inflation, so actual interest is better than originally promised.

In case of deflation

Interest payments decrease with the negative inflation.
However, capital does not decline below the face value, ie. Initial investment, in case of deflation.
1997 – Inflation-linked bonds in the name of Capital Indexed Bonds (CIBs) were first issued
These provided protection only to principal and not to interest payment
2013 – New bonds by the name of inflation-indexed bonds (IIBs) were issued
These IIBs were linked to the WPI.
Now, IIBs are linked to CPI