Inflation-Indexed Bond
An Inflation-Indexed Bond (IIB) is a government security whose principal and/or coupon is adjusted for inflation, ensuring that real returns are preserved regardless of the inflation trajectory.
India has experimented with inflation-linked government bonds at several points in its capital market history. The most recent structure, introduced by the RBI in 2013, was the Capital Indexed Bond (CIB) linked to the Wholesale Price Index (WPI). The structure was designed to offer investors a real return over WPI inflation: at maturity, investors received the inflation-adjusted principal (if higher than the original face value) plus a fixed real coupon on the adjusted principal.
However, the WPI-linked structure drew limited institutional appetite because most institutional investors track CPI for liability matching, not WPI. Retail investors were unfamiliar with the product's mechanics. The government subsequently issued CPI-linked bonds in limited tranches but discontinued the programme after tepid response, attributing the muted demand to low real returns offered and market unfamiliarity.
The conceptual appeal of IIBs is compelling in a high-inflation economy. Fixed income investors in India have historically faced negative real returns during periods of elevated CPI — for instance, the 2010–2013 phase when CPI ran above 9 per cent while savings deposit rates lagged. An IIB that guaranteed a 1.5 per cent real return over CPI would have substantially outperformed nominal fixed-rate instruments in such environments.
Globally, inflation-linked bonds — US TIPS, UK Index-Linked Gilts, French OATi — are established asset classes. The 'breakeven inflation rate' derived from the spread between nominal and inflation-linked bond yields of the same maturity is widely used as a market-based inflation expectation measure. India lacks a liquid IIB market, so this pricing signal is unavailable, which is considered a gap in RBI's toolkit for gauging inflation expectations from asset prices.
The government, in its medium-term debt management strategy documents, has occasionally indicated intent to revive the IIB programme with a CPI linkage and a more transparent principal adjustment mechanism. A successful IIB programme could also serve a social purpose: offering pensioners and conservative savers a real return guarantee without equity market exposure.