Ideal investment for inflation hedging

When the inflation rates have soared consistently; the RBI has started attempts to find out the demand for inflation-indexed bonds. Even when the fixed deposits and bonds down rightly depreciate, inflation-linked bonds bail out an investor. Therefore, it has a scope to attract giant institutional investors like LIC, let alone retail investors.

RBI has to frame a borrowing program assuming the fiscal deficit and fiscal targets. With the inflation rate steering up, the government can't rely entirely on the earnings from government bonds. The government wants to measure the demand for government-linked bonds to avoid the 2013-14 experience. Such a move would help RBI understand what kind of an investment would attract demand among the investors.

The RBI has plans to change the borrowing pattern next year as it is determined to wipe away the liquidity it injected into the economy earlier. As the global bond indices have included Government of India papers, it is easier for the government to borrow from the international arena. These ILB are particularly attractive when the inflation rate goes up because the returns are directly proportional to the increase in the inflation rate. 

When Raghuram Rajan was the governor of RBI in 2013, the RBI started concentrating more on the consumer price index from WPT to take care of manufacturers and consumers' interests. The demand for Inflation Linked bond declined sharply as huge institutional investors no longer invested in them.

As a result, the GOI papers became illiquid. The RBI decided to buy them back following the advice of institutional investors. It would be advisable for RBI to link the bonds to CPI instead of WPI if it plans to issue newspapers in the future. RBI has another brilliant option to link the GOI papers to a harmonised index similar to the European market. Life insurance companies would be interested in investing in such an instrument as they are under pressure to issue products that guarantee returns. Furthermore, the policyholders flooded the insurance company with questions about inflation as they worried it would erode their investment. In light of these circumstances, the insurance companies will hold the investment for a long time.  

Economists believe that CPI will not see steep inflation, unlike WPI. But it would go up to a 0.5% increase in 2022. The November inflation rose to 4.91%, while 4.8% last month. Surprisingly, WPI has shot up to 14.23%, which the government has never experienced before. 

In short, the RBI is on the lookout to introduce inflation-indexed bonds soon. ILB are very attractive when inflation is increasing. Since they are linked to inflation, RBI expects to give high returns to the investors. Unlike last time, RBI should focus on WPI instead of CPI to hold the interest of the Institutional investors in this investment. It can also link ILB to a harmonised index to avoid the previous effort to link the investment to CPI. Previously during 2010 and 2013, the RBI failed to concentrate on WPI altogether. Even though the CPI is rising slowly to keep the bond investment safe, a steep rise in the WPI can be detrimental to the equity market.