SINGAPORE: After a gap of 14 years, India is preparing to follow the example of a number of other developing countries and reintroduce inflation-linked bonds to add depth and diversity to its domestic bond market.
With investors keen to hedge against inflation volatility in India, the product may well find an eager investor audience, but a regularity in issuance and a decent yield are critical for success.
Reserve Bank of India Governor Duvvuri Subbarao announced in the week of September 5 the central bank's intention to introduce inflation-indexed bonds, or linkers. Although a timeframe has not been given, many expect the new linkers to hit the market within three months
Introducing the product will see India join Thailand and Hong Kong as issuers of linkers. Both Hong Kong and Thailand received mixed responses to their linkers.
Linkers in Thailand were more successful as these not only came at a time when investors feared runaway inflation, but were also offered to international investors (37.5pc of the Bt40bn or US$1.32bn deal). In Hong Kong, the inflation bonds were offered only to domestic retail investors.
Hong Kong's HK$10bn (US$1.67bn) linker, dubbed iBonds, attracted subscriptions of HK$13bn in July. The response was less enthusiastic than many analysts had predicted, as most people were waiting for the China Ministry of Finance's renminbi bonds in August and thought the iBonds would not help much in fighting inflation.
The iBonds, however, have performed very well in the aftermarket and climbed to 107.44-107.55 as of September 8, compared to the par issue price in late July, because of institutional investor interest.
The experience of other countries with linkers suggests the RBI will fare best in offering the bonds to both institutions and retailers. The last linkers from India in 1997 had a five-year tenor and were targeted at institutional investors. However, the participation of institutional investors was limited because of a shallow secondary market for such bonds.
"Linkers are most liked by pension and provident funds, which promise fixed returns to their investors. Institutional investors would be interested in the product only to a point there is enough liquidity in such an asset class," said a Mumbai-based banker with a local brokerage firm.
"Linkers will become popular as long as there is periodic issuance of these instruments. It is crucial for the success of any product that there is enough trading and, only then, does it attract all kinds of investors," said Piyush Wadhwa, executive director, fixed income at Nomura India.
Some bankers suggested the RBI should adopt an "on tap" issuance model to create a healthy secondary market for these bonds.
Apart from illiquidity concerns, the response to the issue may take a hit from the fact that many feel inflation in India is peaking.
Inflation bonds insulate investors from inflation risks and, in India this is expected to remain at 9%-10% until December before easing to 6pc-7pc by March 2012.
The RBI governor himself acknowledged the concern surrounding the success of linkers due to prevailing high inflation. Hence, many are presuming that the central bank will make the new inflation bonds more attractive in terms of yield to ensure success.
RBI is planning a new variant of linkers issued in 1997, according to the technical paper on inflation bonds issued in December. Unlike the previous inflation bonds, wherein only principal repayments (at the time of redemption) were indexed to inflation, the new bonds will offer protection on inflation for both coupons and principal repayment, linking them to wholesale price index (WPI) for all commodities.
This time around, the tenor may also be set at seven to eight years as there may not be enough demand in the five- and 10-year segments.
"Statistics are a nightmare in India of which central bank is also aware. For RBI to make inflation bonds a success, the paper needs to be benchmarked with a credible index and I am not sure if wholesale price index, or WPI, is the right one as the composition basket keeps changing so often it may not reflect real inflation," said a New Delhi-based banker.
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