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Commentary

Early Buyers of Inflation Indexed Bonds Lose 5% in a Month, New Auction at 1.99%

The good folks who bought Inflation Indexed Bonds (IIBs) in the first auction earlier this year have already lost 5% in the market, with another 1,000 cr. auctioned today at a yield of 1.9855%, which means a price of 95.10.

Given that the bond was issued at “par” or Rs. 100 in the first auction on June 4 the loss to the holder of the bond is around 5%.

The bond has not traded much recently but today, it saw trading of 155 cr. in the open market. The bond closed at 94.9, which is a yield of over 2%

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Trading in the IIB on 25 Jun 2013

Looking at it another way, what are inflation expectations for the coming year? We can make an assumption that (10yr bond yield minus IIB yield = inflation expectation by the market). If so, the 10 year bond is at 7.67%, so:

WPI Inflation expected = 7.67% – 2% = 5.67%.

(Note: You have to take the 2022 bond as the 10 year benchmark, since the 2023 bond doesn’t trade quite as much.)

This is quite a bit higher than recently revealed inflation figures of 4.70%. But you can’t trust the expectation because trading has been quite thin.

Read: Do Inflation Indexed Bonds meet their objective? by Dheeraj Singh.

Effectively, a bond that is supposed to protect you from inflation has just lost 5% in market value, and just told you that inflation is going to rise from here. While you could hold to maturity and realize some layer of inflation protection, the fluctuation in market value within a month tells you how illogical this instrument is as a protection against inflation.

The market is very shallow here, and there is hardly any retail participation. The illiquidity causes the discount, one thinks. If the yields go to 3 or 4%, this could be a great opportunity to enter. Given that the difference between CPI and WPI is currently around 5%, right now is not a good time.

  • Sanjay says:

    whatever can be said about IIB can also be said about stock market.
    Stocks are also suppose to protect investor from inflation but when interest rates rise (in response to higher inflation), then stocks also fall. In short, there is some instrument available at that time which beats stock market. I guess same instrument is also causing IIB price to fall.
    If RBI had decided to drop repo rates by 1 % then same people would queue up for buying IIB.
    All bond prices are linked to actual inflationary expectation (not the government predicted). Nothing new about it.

  • Ravi says:

    Thanks for the follow-up article on IIBs. Do you think note is a good time to buy them because of the imminent rupee depreciation and the expected increase in inflation?
    Thanks for your time