The government keeps talking about Inflation Indexed bonds – we are not clear when it will come. We have no clue as to how it will be structured in India.
However this is how it should work if they do a cut and paste from the US – TIPS is the US product. Principally this is how it will work – the numbers are of course imaginary. I am not talking about Income tax, tds, etc. I am also assuming that it will be a straight one time payment of interest and not as a bi annual payment (that complicates yield calculation)….
Let us say the bonds are issued for Rs. 1000 each and carry 5% interest rates. In the first year you will be paid Rs. 50 as interest. Let us say the inflation in the first year of your holding the bond is 10%…then the PRINCIPAL VALUE of the bond becomes 1100.
Again the interest rate remains fixed at 5% – and that will be paid on the ADJUSTED PRINCIPAL VALUE …Rs. 1100. This means you will get Rs. 55 as interest.
In the next year if the INFLATION is 5%, the bond value will go up to 1155. The interest paid will be 5% of 1155…..
If the finance ministry does not have any ego…they should cut n paste from TIPS….not sure what they will do….
Knowing the greed of the government, they will make the interest taxable – thus beating the purpose OR worse they will do a TDS on the appreciated amount. Say they introduce a phantom capital gain on the amount by which the bond is incremented every year…..OMG the Americans do that…..
Source: http://www.subramoney.com