RBI held a teleconference for Inflation Indexed Bonds (IIBs) where they clarified a few points. In summary:

• IIBs will work according to the way I mentioned it in my original post. They will release a more detailed FAQ later.
• It is going to be very tough for you to participate in the auctions directly. You have to find a primary dealer who can bid on your behalf, and then transfer the shares to your demat account.
• Since the primary listing area will still be the RBI’s platform (NDS-OM) it’s a pain to sell these bonds once you buy them – first you’ll have to transfer from your demat to SGL account, and then sell from there. If there is good trading in the NSE Debt segment, the SGL step is not required.
• The bonds will qualify for repo, SLR, and short selling. Like any other govt bond, subject to limits like minimum size/liquidity etc.
• Interest will be paid twice a year (like regular govt bonds)
• There will be one bond that is continuously reissued for the first six months – the coupon rate will remain the same for them. Subsequently they may issue a new bond or keep the same.

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We’ve discussed how Inflation Indexed Bonds might work in India, and like in the US, the difference in the yields between the two is likely to be the expectation of inflation. Let’s look at how the spread between the known WPI has been in the past: (this is the 10 year government bond)

Technote: for pre-2004, I have used a base-conversion factor as WPI was reported with a different base year. I know that base splicing should have been used, but I am too lazy to base-splice at this time.

In the last 16 years, we’ve seen that:

• Till 2002, the 10 year bond traded at a significant premium to the inflation number. At one point the difference between yields and inflation was nearly 10%! Till 2001, 10 year bonds paid you more than 10%, an indication of how relatively new our “low” interest rate regime is.
• There was then a period of “negative” yields – where inflation was higher than the 10 year bond yield for a while.
• Post 2005, as the RBI raised rates, 10 year bonds traded at rising yields between 6 and 8%, and inflation stayed lower than these yield.
• The crisis in 2008 led to

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If you buy a fixed income bond, your problem is that as inflation increases, your income remains the same and this gives you a much lower return, net of inflation. One way to solve that problem is to have bonds whose payments are linked to inflation.

RBI has allowed inflation indexed bonds (IIBs) in 2013-14, where they believe the Indian retail investor will keep their money because if Inflation should go up, income also goes up.

How do they measure inflation?

RBI will use the monthly-released WPI number. However they won’t use the most recent number – they would have used the number in Sep-Oct 2012 to finalize numbers for Feb-March 2013 and they’ll interpolate to get to the number on a certain date. (That is, for an interest payment date of March 15, they’ll do a day interpolation of the indexes of Feb and March)

The lag is to allow for adjustments due to revisions. I’ve noted recently that WPI is adjusted often and sometimes significantly (a 0.4% change is significant and it was done for Feb WPI numbers when April numbers were released).

How does it work?

If you pay Rs. 100 for a bond that tells you …

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Wholesale Price Index (WPI) based inflation comes in at a number you wouldn’t believe: 4.89%. But you don’t have to believe it. In Feb they told you WPI was at 6.84%, but it has now been revised back up to 7.28%, above that “comfort” level of 7%.

Component wise, we see the lowest number since November 2009 in Manufactured goods inflation (weight: 65%) at less than 4%,

Wholesale primary articles inflation (largely food) seems to be at 5.75%. CPI Food inflation came in at above 10% for April, yesterday. This means someone’s making this massive spread between retail and wholesale prices, it seems.

If there’s one reason I can’t understand the spread, it’s that the same thing seems to inflate very differently in the CPI versus the WPI. For example, “Fruits” are up 8% in April 2013 in the CPI, while the WPI shows, for the same category, just 0.7%. Vegetables, 5.4% in the CPI but a huge NEGATIVE 9% (-9%) in the WPI. This just doesn’t make sense.

Of course the main reason why I don’t believe the headline number is: massive revisions. Again, the index for Feb 2013, originally announced at 6.84%, is now above 7%. …

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Consumer Price Inflation Fell to 9.39% in April 2013, says MOSPI released data. The WPI for April 2013 will only be released on Wednesday, but the trend looks down.

Food remained above 10% on a year-on-year basis, Fuel costs went up 8%, Clothing and Housing 10%. Transport costs have been rising as well, reflecting the increase in diesel costs.

Rural Inflation came down sharply to 9% while urban inflation remained above 11%. This sounds very strange.

CPI for March 2013 has been revised up marginally, but the data shows a definite downtrend. These figures are more believable than others. Food prices will now determine the future course of CPI inflation, and that will depend on the monsoon.

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Inflation in the Wholesale Price Index (WPI) came in at a headline number of 5.96% for March 2013, which not just raises eyebrows but brings the words Whisky Tango Foxtrot into mainstream vocabulary.

What you don’t see here is that

Inflation for Jan 2013 has been revised UP from 6.6% to 7.3%.

This is the biggest revision since, surprise, March 2012! (which was revised up by 0.80%)

The inflation number for Jan 2013 was first announced as 6.62%. Now it’s gone up to 7.3%. In Jan, we thought Inflation has come down since December. Not true, it’s now revised to the same level as December!

Essentially, the first number that went under 7%, didn’t.

Of course, if you look at components the data seems serious bonkers:

While Fuel inflation has remained high (10%+) Primary articles – mainly food – is down from 11% to 7.6%. This is ludicrous, because the CPI number (consumer prices) showed food prices at the retail level were up 12%+. The “spread” is not that much, senor.

I’m almost definite that this 5.96% number will be revised sharply upwards. Effectively I have no confidence in this number.

Bond markets don’t seem to be pleased as the …

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Consumer Price Inflation came in at 10.39% for March 2013, down from the Feb 2013 number of 10.91%. This is still way too high a number for comfort, given that it’s prices consumers face. Wholesale price numbers come in on Monday but recently there has been a huge divergence between the two. From a component [...]

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In a stark difference from whatever the Wholesale Price Inflation guys are smoking, consumer prices have now left the building through the roof. At nearly 11%, the Consumer Price Index (CPI) has inflated substantially more than the “minor” 6.84% in February. And it’s largely food, which has gone up 13.4% from last year. As you [...]

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February 2013 has shown a small jump in Wholesale Price Inflation to 6.84% (from last month’s 6.62%) Much about the low number is really the lack of inflation in manufactured goods (4.51%) whereas both food and fuel inflation are nearly 10% above last year’s levels. However, it doesn’t seem like we can rely on this [...]

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2013 rings in with a Consumer Price inflation of 10.79% and urban inflation above 11%. It’s really time to stem the rot. With the continuous retrograde focus on wholesale prices, which either don’t get updated on time or are simply not reflecting reality, the government and RBI (which recently cut rates) have lost the plot. [...]

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