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?

The correct option is 1 and 2 only.

Explanation:

Statement 1 is correct: Inflation-Indexed Bonds (IIBs) provide a hedge against inflation. Because investors are protected from inflation risk, they are willing to accept a lower real yield. This allows the government to issue these bonds with lower coupon (nominal interest) rates compared to conventional fixed-rate bonds, thereby reducing its cost of borrowing.

Statement 2 is correct: The primary objective of IIBs is to safeguard both the principal amount and the interest payments of the investors from the eroding effects of inflation. By adjusting the principal value according to inflation index tracking (like the Consumer Price Index or Wholesale Price Index), investors are guaranteed protection against inflation uncertainty.

Statement 3 is incorrect: There is no tax exemption on IIBs unless specifically provided. The interest income received from these bonds is taxable under the Income Tax Act, and any capital gains realized upon redemption or sale are also subject to capital gains tax as per applicable tax laws in India.