The time has come for inflation-indexed 'granny' bonds

Topics Bonds | tax-free bonds

The Reserve Bank of India (RBI) recently announced that retail investors would be allowed to buy government bonds. And thereby hangs a personal tale. 

About 40 years ago I joined the Financial Express as a leader writer. The editor was one of the three doyens of financial journalism. He had just turned 60 and was looking for some inflation-proof investments.

Inflation since 1979 had been running at around 15 percent. In 1980 it touched 22 percent. So his search had urgency. 

He asked me to write an editorial on something I didn’t have the faintest clue of: granny bonds. In fact, I barely knew what even a bond was. 

The Internet was not even a gleam in anyone’s eye and research was hard. Eventually, however, I managed to complete the assignment and produced 600 words of--as it turned out--drivel. The editor rewrote the whole thing. 

Since then the concept of granny bonds, invented by the British, has always been at the front of my mind. They are wonderful things to invest in, especially for non-government retired people, who need inflation-proofing very badly. 

After all, as a friend recently pointed out, the post-tax return on a fixed deposit in a bank, with inflation at 6 percent is -2 percent. And, as inflation goes up, so will the negative return. 

It was to solve this problem that the granny bonds were introduced in Britain. After the second oil shock of 1979 they, too, had very high inflation. 

These new bonds, which became available in 1981, could be bought only by pensioners. The interest wasn’t very high. 

But it was linked to an index such that the real return always stayed higher than inflation. This prevented savings from depreciating in real value. 

As of two years ago such bonds comprised $3 trillion of international sovereign debt. 

Crucial for India

The need for these bonds has taken on both economic and political significance today in India. 

Economic, because they help the vulnerable fixed income groups and obviate the need for tax-free bonds. 

Political, because this group has almost decisively turned away from the BJP. And compared to even ten years ago there are a few million more of them. 

Apart from inflation indexing--babus have inflation-indexed their pensions--India has a tradition of ‘lock-in’ which was ok, just about, if you got a tax break, you know, EEE etc. But since that’s gone now, lock-ins only impede liquidity. 

Consider the RBI bonds today.  They have a floating rate about 7 percent but are totally locked in for 5-7 years. 

Not just that. There are too many hassles if you want to liquidate them. Pensioners just don’t want such bonds. 

Macro reasons

People often say that the system of administration in India has remained colonial in its basic disk operating system. This is absolutely correct. 

But what they don’t realise or talk about is the idea of sovereign entitlement has been extended, as per colonial views and methods, to the market also.

I have studied this aspect in some depth and can see how the British treated their own financial markets and how they treated ours. Very differently. 

Markets in India were treated as a variant of taxation wherein the government had preemptive rights. This tradition, instead of being given up, was strengthened by the Congress. 

The BJP, instead of making a break with the tradition, has accepted it blindly. You can see it in the hesitating way in which it has approached financial sector reform--in processes rather than a world-view. 

Mr Modi has another small but significant opportunity to make things better. One must hope that he makes a beginning with the Indian version of granny bonds. 

Politically that could well be the only worthwhile thing to copy from the British. 

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