Review of Indian Economy & Markets - Week ended 26th September 2015

• With Bihar Assembly elections in the month of October and Prime Minister’s Visit to USA to attend UN General Assembly and meet CEOs of Silicon valley companies for investments in India, nothing much happened domestically. Many of the ministers of Ruling Party BJP are camping in Bihar for campaign with each of them camping there for at least 2-3 days and one Public Holiday in the middle of the week, this week can be taken as rather dull.
• As per the figures released by the Reserve Bank of India, Corporate India’s foreign borrowings increased by around 48% in the month of August 2015 compared to same month previous year. This is by both automatic approval route as well as External Commercial Borrowings. The borrowings in August 2016 stood at USD 750.76 Million in August 2015 compared to USD 507.40 Million in August 2014.
• The Reserve Bank of India (RBI) has notified norms that allow banks to upgrade credit facilities extended to borrowing entities upon a change in ownership, so long as the ownership has been changed outside ‘Strategic Debt Restructuring Scheme’. The move would further enhance banks’ ability to bring in a change in ownership of borrowing entities which are under stress primarily due to operational/ managerial inefficiencies despite substantial sacrifices made by the lending banks.
• In a big relief to foreign firms, government announced that the Income Tax Act will be amended with retrospective effect to exempt from minimum alternate tax (MAT) the overseas companies that covered under double taxation avoidance agreements (DTAAs). Foreign companies that do not have a permanent establishment in India will be exempt from paying MAT on profits from April 2001. The provisions of Section 115JB of Income Tax will not apply to foreign companies with effect from April 1, 2001, if they are resident of a country with which India has DTAA and they do not have a permanent establishment (PE) in India, said an official statement.
• As per the advance estimates of Ministry of Agriculture, the output of Groundnut, Coarse Cereals, Tur (Redgram), Cotton, Maize, Rice in Khariff may be down while that of Urad (Blackgram), Castor Seed and Soy bean are expected to go up.
• With the anticipated arrivals of the imported goods, the prices of pulses eased by around 4-5% in wholesale markets. Same is the case with Onions. However, not much change is observed in rates of Pulses in Retail Markets. However Onion prices started coming down marginally during this week.
• With Urea imports surging by 43% in April – August period compared to last year and the deficient monsoon till September, the country is sitting on a stockpile of the fertilizer.

Markets

Indian Equity markets closed this truncated week lower by 1.4%. Both the stock market indices viz., Sensex and Nifty ended lower due to weakening of Indian Currency against USD, weakness in global markets. Metal stocks ended lower due to continued weakness in Chinese Economy and stockpiling of metal stocks with that country. Net flows from FIIs turned negative. The declines were more than advances as the Nifty fell by nearly 169 points before recovering marginally.

Following are the top gainers and losers in Nifty during the week

Ganiers	% change	Losers	% change
IDFC	5.2	Tata Motors	-8.1
Lupin	4.8	NMDC	-8.1
Cairn India	4.6	Coal India	-7.3
Maruti	3.8	Bharti Airtel	-6.7
Infosys	3.3	JSPL	-6.5

Market focus now shifts to Reserve Bank of India which expected to come out with Monetary Policy on 29^th September 2015. With a lot of pressure both direct and indirect on the Reserve Bank Governor, the general consensus is that the benchmark rates may be cut by 25 basis points. We can expect choppy markets if this does not turnout as expected.

Currency

USD strengthened against INR during this week from INR 65.868 on 18^th September to INR 66.16 on 23^rd September 2015 due to the expectation of a rate hike later this month by Fed as well as increase in month-end demand from importers. Sustained outflows by Foreign Portfolio Investors to the tune of nearly USD 190 – 195 Million also contributed for this weakening. 

Review of Indian Economy & Markets – Week ended 19th September 2015

• As per the figures released by the Ministry of Commerce and Industry, India’s merchandise exports registered a decline of 20.66% in Dollar terms (decline of 15.22% in Rupee terms) during August 2015 compared to August 2014. Exports for the period April – August 2015 declined by 16.17% (10.94% in Rupee terms compared to the same period last year. Global economic slowdown is a major cause for this decline. Merchandise exports contribute to around 15% of country’s GDP.
• Compared to August 2014, exports of Rice (-21.26%, other cereals (-40.10%), Iron Ore (-29.75%), Engineering Goods (-24.23%), Petroleum products (-44.30%) contributed to the negative growth in merchandise exports in August 2015 while Pharmaceuticals (13.33%), Jute Products (57.07%), Handicrafts & handmade carpets (54.46%) and Tea (10.68%) registered a growth.
• Imports also registered a decline of 9.95% at USD 33.74 Billion in August 2015 compared to August 2014. The decline in Rupee terms is around 3.77%. The imports for the period April – August 2015 were down by 11.61% (-6.06% in Rupee terms) compared to April – August 2014. In August 2015, imports of Project goods (-46.04%), Petroleum, Crude & Products (-38.65%), Coal, Coke & products (-16.12%) contributed to the decline compared to August 2014. Gold imports registered biggest growth of 150% in August 2015 compared to August 2014 with imports of Fertilizers and silver contributing substantially. Urea imports surged 43% during the April – August period compared to same period last year. 
• Government reduced import tariff on Gold and Silver to USD 359 per 10 grams and USD 470 per kg respectively - With the commencement of festive season from September 17 (Ganesh Chaturdhi) which will continue for next 2-3 months, the imports of Gold may go up further in coming months.
• Government has permitted foreign investment in partly paid shares and warrants to give a fillip to Foreign Direct Investment in India.
• Government imposed a 20% provisional safeguard duty on certain categories of steel imports including hot rolled flat products. This is expected to provide the much needed relief to domestic producers by curbing imports.
• Rainfall deficit in India since June 1 this year is around 16%.
• In April – August period acreage under paddy in Andhra Pradesh (one of the top producers of Paddy) declined by 245,000 hectare due to failure of monsoon and non-availability of water in reservoirs. With deficient rain fall across India by around 16%, there is a possibility of reduction of acreage under paddy and other crops during this Khariff season. However, the revival of monsoon in September may provide much needed soil moisture for Rabi crops reducing the possibility of spike in food grain prices.
• In line with the announcement in budget speech about reduction of corporate income tax rate to 25% in four years, the Finance Ministry announced that the list of tax exemptions to be phased out will be brought out shortly.
• The central statistical office (CSO) has revised the base year of Consumer Price Index (CPI) from 2010 to 2012 with effect from the release of indices from January 2015. As per the indices, the combined CPI for August 2015 (Provisional) is pegged at 3.66% compared to 3.69% for July 2015 (revised) and 7.03% for August 2014. As per the data released the rural CPI increased from 4.35% in July 2015 (revised) to 4.47% in August 2015 (provisional). However the urban CPI declined from 2.94% in July to 2.67% in August. It is also to be noted that both rural and urban CPI declined from levels of 7.67% and 6.39% in August 2014 to levels reported in August 2014 - Though the indices report decline, one did not see much decline in prices in day to day life. In fact most of the prices are ruling at higher levels compared to those observed in previous month.  
• There is little change in prices of Pulses and Onion during this week though there is a 4-5% decline in wholesale prices of Pulses due to starting of arrival of imports. However, there may not be much improvement in prices of Red gram (Tur Dal) till December 2015 till the arrival of new crop.

Markets

Indian stock markets closed positively during this week with Sensex and Nifty recording a growth of 2.47% and 2.17% respectively over previous week after the much awaited US Fed rate review became a non-event as the FOMC meeting decided to keep the bench mark rates unchanged. The focus now shifts onto September 29 when Reserve Bank of India announces the policy as there is mounting pressure on RBI Governor to reduce the benchmark rate.

Nifty reclaimed the 8000 levels intraday but closed the week at 7982 registering 2.47% growth. Only DIIs were the net buyers this week at INR 10.88 Billion. Nifty Managed to hold 100 WMA (weekly moving average) which is at 7,634. Top six Sensex companies viz., RIL, HDFC, SBI, Infosys, HDFC Bank and ONGC added INR 263.46 Billion in market capitalization while TCS, ITC, Coal India and Sun Pharma lost INR 147.66 Billion in market capitalization.

Top 5 Nifty Gainers	Top 5 Nifty Losers
Tata Power Company	Tata Motors
Axis Bank	Larsen & Toubro
Power Grid Corporation	Tata Steel
Sun Pharma Industries	Cairn India
JP Associates	Bajaj Auto

Companies from Construction, Power and Banking sectors reported a positive growth in stock prices while those from Engineering Sector registered a decline.

Currency

The USD – INR exchange rate improved from INR 66.412 / $ on 31^st August 2015 to INR 65.868 / $ on 18^th September 2015. The decision of FOMC not changing the benchmark rates has contributed to this improvement the in exchange rate in the last 2-3 days. 

Review of Indian Economy & Markets - Week ended 12th September 2015

Round-up of Indian Economy and Markets during just concluded week.

Index of Industrial Production (IIP) for the month of July was released during this week. Industrial output recorded a growth of 4.2% during the month July. This growth was possible due to the growth in outputs of Manufacturing, Capital Goods and Consumer durable segments. Trend in IIP during from January 2015 till July is as follows

Please note that IIP for June was initially estimated at around 3.8% but was revised later to 4.4%.

A look at the components of IIP indicates that except for Consumer non-durables every other segment showed a good growth over same month previous year.

• Manufacturing sector up 4.7% in July 2015 compared to 0.3% down in July 2014
• Capital good sector up 10.6% in July compared to 3% down in July 2014
• Consumer durables up 11.4% in July this year compared to 20.4% down same month last year
• Consumer non-durables down 4.6% in July 2015 compared to 5.2% up in July 2014.

It is generally expected the IIP continues to show good growth in August onward. However there is a possibility of it showing a reduction (in my opinion) in September - November period more particularly in Consumer Durable sector as Rural India is reeling under near drought conditions and may postpone consumption during the festive season.

Government approved the proposal to introduce Gold Monetization scheme and Sovereign Gold Bond scheme during this week. The idea of introducing such a scheme was expressed by the Finance Minister during his budget speech. The Gold Bond scheme is expected to reduce the demand for physical gold and the Monetization scheme is expected to release physical gold lying with Indian public to Government which in turn can sell the same to Jewelers.

Government approved the Spectrum Trading guidelines for Telecom Companies during this week. Spectrum is the bandwidth leased by the Central government to Telecom companies (Telcos) to offer their mobile telephone and other related services. By allowing the trading of spectrum between telcos, many companies can share the same bandwidth which was not allowed earlier. This will increase the capacity of the telcos and provide them an opportunity to offer better services to consumers.

Coal linkages were announced to NTPC's  1320 MW Barh Thermal Power plant. This will reduce the cost of generation of this plant by 50% to around INR 2 per unit.

The ruling party again will get into the election mode starting from this week after the announcement of polling dates for elections to Bihar Assembly. As the Prime Minister is the main campaigner for the party and the  Parliament is in recess there may not be many important policy decisions during this period.

Prices of pulses continue their upward journey unabated for quite sometime now. As per the Government of India estimates, Arhar (Red gram) prices went up by around INR 50 during the April - September period while as per the market information the prices went up by INR 30 in the last month itself. Arhar, Urad (Black gram) and Moong (Green gram) are ruing above Rs 130, Rs 120 and Rs 100 per kg respectively during this week while they were at  around Rs 80, Rs 82, Rs 90 per kg same period previous year. Central Government at last took notice of the situation and started taking corrective measures. Import of 10, 000 tonnes of Arhar and Urad is already in pipeline and expected to reach Indian shores around third week of September. Tenders were floated for import of another 5.000 tonnes. Instead of a knee-jerk reaction, Government should have initiated these measures some months back itself to reign in the prices.

Onion prices though got stabilized still ruling at around Rs 60 - 80 per kg during this week. Mumbai and Delhi are getting onions from Egypt and Afghanistan now. Government will be importing  1000 tonnes over and above 10,000 tonnes planned. However the prices are expected to rule around this level till October.

Stock Markets

Markets remained volatile during this week albeit recovering a bit. Nifty and Sensex went up by 1.75% and 1.60% respectively during this week. Nifty closed at 7789.30 at the end of the week. The index managed to stay over the 100 WMA (weekly moving average) which stood at 7634. Major gainers this week were Real Estate, Automobiles and Engineering Sectors while FMCG, Pharma and Energy sectors were major losers during this week.

Though the markets recovered by around 1.74% this week, they are still down from the levels at the close of August 2015. Volumes are showing a declining trend in the last two sessions of trading and may remain cautious for some time in the near future due to the expectations on the outcome of Federal Reserve rate review.  

Review of indian stock markets & economy - Week ended 4th September 2015

This is my first effort on weekly reviews. Will try to add more details over the coming days.

 

Indian stock markets (based on Nifty) slumped by 4.4% during this week. This is the second time during the current financial year Nifty lost more than 4% during a week. With the current plunge in markets Nifty falls to a low of 7626 in this week which is a 55 week low. 

The index is currently hovering around the 100 week moving average of 7618 which was not tested during the past 2 years. Any fall below this level may see further downward movement in the markets more on sentiments than the economic factors.

The market volatility levels increased by around 12% during the current week compared to the previous one. 

In effect this literally wiped out all the wealth creation which happened in the past 1 year (after the euphoria of electing Bharatiya Janata Party to form a central government with an overwhelming majority).

There may be several reasons for this downfall witnessed in the recent weeks

• Mishandling of the economy by the earlier government - could have been put back on rails by current dispensation
• Melt down of Chinese Economy
• Continuous decline in Industrial production - down 8 out of 15 months (April 2014 - June 2015) which is more than 50% of the time
• Decline in exports for a continuous 5 months during the current financial year
• Fears on US Job data (which for August 2015 stood at around 173,000 less than estimated figures)
• Fears on a probable rate hike by US Fed Reserve by the end of this month

There are some additional worrying factors

The country witnessed a sudden (though) a seasonal increase in prices of Onions which forms a part of the staple food of the country. Not sure whether the import plan of 10,000 metric tonnes through MMTC (a PSU). As per the news reports the tender was floated only in the last week. Though the government promised some change in 48 hours around one week ago there is hardly much reduction in Onion prices. 

There is a news report in Hindu Business Line that the Tomato (another important vegetable used in India after Potato and Onions) prices started going up in Northern India. Hope the government will take necessary steps to arrest the prices of Tomatoes.

The country achieved 69% of the Fiscal deficit target for the whole Financial year 2016 (April 2015 - March 2016) during the period April - July 2015 itself. Unless proper steps are taken there is probability of overshooting the targeted fiscal deficit by the end of the year.

The Quarter on Quarter GDP growth rate declined to 7% from 7.5% during the current quarter (April - June). If this continues further there is a possibility of the country ending with a growth rate of around 6.5% - 6.7%. If this is the expected growth rate on the newly constituted base data, imagine what cold be the growth rate on earlier base data.

I expect that we should tighten our belts for more bumpy ride during the current financial year.

Crude oil may not stay at USD 50 a barrel or below for long

In an article today in an Indian News paper "Business Standard" there is a caution that the current celebrations about low crude prices may not be there for long. The link for the article is given below

http://www.business-standard.com/article/markets/four-reasons-why-the-latest-crude-oil-price-crash-may-not-be-sustainable-115010800845_1.html

According to the article, the crude prices have come down because of

• Raising US Shale Oil Production
• Insistence of OPEC (Organization of Petroleum Exporting Countries) to continue production to maintain its market share
• Slump in demand from major importers

However this continued reduction may not be sustainable in the long run as according to the author, a price below USD 60 is not beneficial to the US Companies into production of Shale oil due to costing. A second factor is the shrinkage of oil revenues of major oil producing countries like Russia (Oil accounts for nearly 45% of budgeted revenues) and Venezuela. This may result in defaults by these countries on their bonds which can result in an international economic crisis.

In my opinion (based on common sense as I am not an expert of Oil industry), the price fall will be a short term phenomenon due to following reasons

1. Oil being a natural resouce has only a finite reserve (unless we discover some huge reserves and start exploiting them)
2. Nobody will produce and sustain below costs for a long time
3. A default by some of the oil producing nations on their bonds due to shrinkage of revenues will result in a major international economic crisis which everybody scrambles to avoid.

Indians meeting majority of their demand through imports benefited a lot from this fall in international crude prices. The prices of petrol came down a record 10 times in the last six months despite Government ploughed back the reduction on two times by increasing the excise duty. There is a significant reduction in inflation based on Wholesale Prices - In fact it became zero in the last quarter. However, there is not much difference with regard to consumer prices. Earlier whenever there was a hike in petrol and diesel prices the prices of daily needs like Vegetables etc., used to go up. But the reverse has not happened now. May be the government should look at this for the welfare of common citizens.

Lesser Known / Less Followed Companies in Indian Stock Markets - Gravita India Ltd

Hundreds of Indians companies are traded on Indian stock exchanges. The major Indian stock exchanges are National Stock Exchange (NSE), Bombay Stock Exchange (BSE – Oldest stock exchange in India). Apart from these there are several regional stock exchanges operating from other Indian cities and are lesser known and less followed. Out of the hundreds of companies a limited number of companies are only followed by investors likes those which are included the stock indicies and some of the popular ones. In this series of blogs will be talking about those companies which are consistent performers over the years but are less followed by the investors.

The first in this series is a company called Gravita India Ltd

What the Company does?

Gravita India Ltd is the flagship company of Gravita Group which has manufacturing facilities in Asia, Africa.

Gravita India Ltd is a small cap company engaged in manufacture of Pure Lead, Lead Alloys, Lead Chemicals like Oxides and specific Lead products like sheets, pipes etc. The company is a certified Star Export House by Ministry of Commerce and Industry, Government of India.

Where?

The manufacturing facilities of the company which are spread across several countries in Asia and Africa has a capacity of 86000 MT per annum. Their main processing facility is located near Jaipur, Rajasthan in India is ISO 9001-2000 certified and has a capacity of 27600 MT per annum. The company is also operating thorough eight fully owned subsidiaries and associated companies in international markets.

How ?

Gravita imports lead scrap from several sources like lead batteries, plates, cable stripping, blocks etc and lead ores to manufacture the products. They are engaged in recycling and smelting activities

Since When?

Gravita is into the manufacture of Lead for the last 15 years.They started their business in 1992-93 in the business of welding technology and powder metallurgy of surface coatings. They diversified in 1997-98 into manufacture of Lead. Gravita came out with an IPO in the year 2010 and was listed on BSE & NSE.

Share Holding

As per the latest available data, the company has a paid up capital of INR 136.35 Million. The holding pattern is as follows:

Type of Investors	% of Holding
Promoter Group	73.42
Foreign Institutional Investors	7.67
Bodies Corporate	8.53
Other investors (individuals)	10.38

A graphic representation of the same is as follows

The company is a closely held one with promoters controlling 73.42% of the share holding. Currently none of the MF hold stake in this company. With regards to the retail investors, around 95% of the shares held by Individual investors is held by those owning less than 5000 shares.

Management

Designation
Mahavir Prasad Agarwal	Chairman & Whole Time Director
Rajat  Agrawal	Managing Director / Chief Executive Officer
Rajeev  Surana	Whole Time Director
Mrs. Leena  Jain	Company Secretary & Compliance Officer
Mr. Naveen Prakash Sharma	President & Chief Executive Officer

The management is experience in the business for more than 3 decades and committed to the activity as can be seen from the promoter holdings remaining relatively unchanged over the years.

Products & Markets

Company is involved in manufacture of Lead alloys, sheets, Lead chemicals etc. Most of these products find use mainly in automobile market in the form of Lead Acid Batteries. Automobile markets in India were subdued 2012-13 and contunues to be in the same state in the current financial year also. The company being dependent on the automobile market to a large extent will also feel the effects of such a slow down in supplier markets. To mitigate this effect the company has expanded into international markets and in domestic markets is concentrating on other sectors which also find use for the lead like roofing, power generation etc.

The global market also has seen substantial fluctuations in Lead prices as well as the stocks. Also there is an oversupply of Lead in the international markets which result in reduction of margins. This is also expected to continue further in this year also. To derisk from this reduction in margins the company is concentrating on emerging markets and roofing, towers, turnkey solutions which improve the margins.

Financials

Financial performance of the company over the last three years is as follows

(INR in Million)

	2010-11	2011-12	2012-13
Sales	1587.67	2536.82	4022.7
PBIT	166.37	197.34	324.3
Interest	7.34	15.62	55.8
PAT	132.16	143.79	235
Share Capital	100.2	136.2	136.2
Reserves	192.92	638.71	857.65
Loan Funds	212.21	285.68	938.22
Current Ratio	3.03	4.27	1.61
Interest Coverage	20.06	7.89	4.21

Company's activities grew substantially over the last three financial years resulting in more than doubling of the balance sheet size. Though most of this growth is financed through loan funds, the company was able to plow back substantial amounts to reserves. Also the interest coverage is still a comfortable 4 times. Any fall in this ratio below 3 may have troubles for the company

Performance in 2013-14

Gravita achieved a 11% growth in turnover from INR 66.79 million in quarter ended 30^th June 2013 to INR 74.74 Million in September 2013. The net profit doubled over the previous quarter. However the net profit declined from INR 4.73 Million in the September 2012 to INR 1.12 Million in September 2013 due to a slowdown in the automobile markets.

Stock Market Performance

Stock market performance of Gravita is as follows

52 Week High (adjusted)	172.00(30/01/2013)
52 Week Low (adjusted)	20.80(24/06/2013)
52 Week High (Unadjusted)	172.00(30/01/2013)
52 Week Low (Unadjusted)	20.80(24/06/2013)
Month H/L	53.45/35.90
Week H/L	49.60/45.35

Due to a stock split in May 2012, there is a adjustment of stock prices in that year. The performance largely is inline with the index performance in most 2012 and 213 which is basically subdued. During the last 4 months there is a 75% increase in the stock price of Gravita which considering the expected good performance in last quarter may continue to go up further.

Dividends

Gravita is consistently paying dividends in the last three years. The company paid interim dividends based on the performance upto the particular quaters. The dividend data is as follows

	Dividend Per Share
22 Jul 2013	0.3
06 Feb 2013	0.3000
05 Sep 2012	0.2000
30 Jul 2012	0.6000
15 Feb 2012	1.0000
20 Jul 2011	4.0000

Future Outlook

Though the automobile market continues to be in a subdued mode with most of the automobile companies and spares suppliers reporting losses or reduced profits. However, the sector is expected to comeout of these lows possibly in second quarter of 2014. The may be a filip to economy around the same time due to a possible change of government in general elections. Apart from this the company is concentrating on other markets and other business activities like turnkey projects to de-risk its business. A good performance from this stock can be expected in the coming months.

Disclaimer

The above is prepared from the public sources available through internet and company financial reports and is not sponsored by the company. This is not an invitation to invest in this company. Nor this is a financial advice solicited / unsolicited. The investors are expected to do their own due diligence prior to taking any investment decision.

Inflation Indexed Bonds in India

Reserve Bank of India (RBI) which is the central bank of the country has recently started issuing inflation indexed bonds as proposed by the Finance Minister of India. Though this is not a new type of investment venue elsewhere in the world, this is the first time the Government of India introduced this class of investments in India. The first inflation indexed bonds were issued in UK in 1981 and became popular in developed markets over time. In US these are known as Treasury Inflation Protected Securities (TIPS).

Reserve Bank of India has issued the first tranche of the bonds with a 10 year maturity period during early June and the issue was oversubscribed by 4 times. These bonds were indexed to Whole Sale Price Index (WPI).

What is a Bond?

Bonds are fixed investment securities through which an investor can invest amounts in an entity be it a corporate or Government or Government entities like Municipalities etc.,  and can receive periodic interest payments (known as coupon payments) and principal on maturity. The interest payment is often on half yearly basis or annual basis. There is a whole host of instruments available under the bonds like Zero Coupon Bonds, Bonds with call option, Bonds with stepped coupon payments etc. Many banks, financial institutions, brokerages have separate desks in their treasuries with hundreds of thousands of professionals exclusively working on fixed income securities. Among these types of bonds available for investment elsewhere and now available in India is the Inflation Indexed Bond.

What is Inflation Indexed Bond?

Inflation is the rise in prices over a period of time. Each country generally defines a set of goods for calculating the price index. The set includes items of staple food of the country, products produced or consumed by the people in that particular country, fuel and any other relevant goods. The price index is calculated on a regular interval say monthly, quarterly etc. Based on the difference between the earlier level of index and current level the inflation is calculated as a percentage.

Understanding the inflation rates in a country is important for the governments and central planners / central banks for setting up and modification / fine tuning of economic policies. In an ideal situation, the interest rates in a country should be linked to the inflation levels, though in practice several other factors also play a part. The interest rate net of the inflation rate is the real interest rate which is available to the depositors / investors. For example the current interest rates for one year is 9.5% and the annualized inflation rate in the country is around 8.5%, the net interest return for the investors is 1% only.

This also follows the general economic principle that a rupee in hand is worth more in general compared to one which we are expected to received at a point of time in future. The value depends on the interest / income expected to forego the utilization of the rupee now, the expected inflation rates and any other factors like opportunity cost etc. In case the current interest rate is around 9% and expected inflation levels are around 10%, the investor ends with a negative return of 1%. That the amount he is going to receive in future is worth less in real terms than what he currently has on hand.

It is here the inflation indexed bonds or any other similar financial instruments play a role to mitigate the inflation risk. In case of these financial instruments, the instruments will be issued with a positive real interest yield based on the inflation rate prevailing in the country at that time. The interest rates are reset at a periodic interval based on the inflation levels in the country at that time.

For example, an issuer issues a bond with a face value of INR 100 for a period of 3 years with a coupon rate of 8% (indexed to inflation) and coupon is payable at half yearly intervals. Suppose the inflation rate at the time of issue of the bonds is around 6%. The price index based on which the bonds were issued is 100 and after six months it is 106. The net yield to the investor will be 2% (8%-6%). After six months, say the inflation rate in the country is estimated at 7%, coupon rate till the next reset will be adjusted upward to 9% (7%+2%) and vice versa.

Another way of issuing the bonds is that instead of adjusting the interest rate, the principle will be adjusted to the extent of inflation rate which will in turn results in adjustment of interest payments also. The calculations could be something like below

Inflation index = Price index at the time of coupon payment / Price index at the time of Issue

Coupon payment = (Inflation index X principal) X coupon rate

If we take the above example

Inflation index = 106/100 = 1.06

Coupon Payment = (1.06 X 100) X 8% = INR 8

Say at the time of second coupon payment, the price index is 107, then the above calculation looks something like below

Inflation index = 107/100 = 1.07

Coupon Payment = (1.07X100)X 8% = INR 8.56

The difference between the two variants is that in the first the principal is not adjusted for the inflation while in the second this part also is taken care. In general the second variant is more popular.

Pros and cons of Inflation Index Bonds

Inflation Index bonds benefits investors during the periods of high inflation as it protects their real interest yields. These bonds also will take care of the principle adjustment to account for the inflation rate.

On the flip side, in times of stable or reducing inflation these bonds will result in reduced payments as well as reduced principal amounts. Also the price index taken into account for indexing may be different that what affects the investors in general. Say for example, there are two types of price indexes in India viz., Wholesale Price Index (WPI) and Consumer Price Index (CPI). The composition of these two indices are different and the inflation rates arrived at also are different. Say the inflation rate arrived at through WPI route is 6%, there is a possibility that the inflation rate based on CPI will be much higher as the composition of goods in CPI is more towards consumer items like stable foods, fuel etc. In this scenario the coupon payments and principal adjustments will not be exactly beneficial to an investor more particularly a retail one.

On the whole in a country like India where the inflation rate is high and often peaking up sharply in a very short span of time and based on the rainfall and other factors, these investments could be a good option made available to the investors.