Q. With reference to the Indian economy, what are the advantages of “Inflation-Indexed Bonds (IIBs)”?
1. Government can reduce the coupon rates on its borrowing by way of IIBs.
2. IIBS provide protection to the investors from uncertainty regarding inflation.
3. The interest received as well as capital gains on IIBs are not taxable.
Which of the statements given above are correct?
a) 1 and 2 only
b) 2 and 3 only
c) 1 and 3 only
d) 1, 2 and 3
Correct Answer: a) 1 and 2 only
Question from UPSC Prelims 2022 GS Paper
Explanation :
Inflation-Indexed Bonds (IIBs) UPSC
Inflation-Indexed Bonds (IIBs) are a type of bond designed to help protect investors from inflation. The principal amount of the bond is indexed to inflation, ensuring that the purchasing power of the investor’s money is maintained.
Benefits of IIBs for Government Borrowing
Government can reduce the coupon rates on its borrowing by way of IIBs. Since IIBs provide a hedge against inflation, investors are typically willing to accept lower nominal coupon rates on these bonds compared to conventional bonds. The real return is adjusted for inflation, so the government can issue these bonds with a lower coupon rate, potentially reducing its cost of borrowing.
Protection from Inflation Uncertainty
IIBs provide protection to the investors from uncertainty regarding inflation. The principal value of IIBs is adjusted according to the inflation rate, which means that the returns on these bonds are designed to keep up with inflation. This protects investors from the erosion of purchasing power that can occur with fixed-rate bonds during periods of high inflation.
Tax Implications of IIBs
The interest received as well as capital gains on IIBs are not taxable. This statement is incorrect. In India, like many other countries, the interest received on bonds is typically subject to income tax. Capital gains from bonds may also be taxable depending on the holding period and applicable tax laws at the time of sale or redemption. There may be specific tax-exempt bonds issued by the government, but IIBs do not inherently come with a tax exemption on interest and capital gains.
