Inflation-indexed bonds (IIBs) are an idea whose time had arrived long ago. The aam aadmi has seen his real incomes being eroded by persistent inflation since the end of 2009, affecting his capacity to save. The drop in savings from 34 per cent of GDP in 2010-11 to 30.8 per cent in 2010-12, and perhaps less now, points to the impact of inflation. The rise in gold imports since February 2010, coinciding with the inflation surge, suggests that gold is viewed as an anti-inflation hedge. Gold imports may taper off once IIBs become popular, bringing funds back into the financial system. But for that to happen, IIBs must truly offset the impact of inflation. Will their link to wholesale prices serve that purpose?

IIBs are not only about restoring the primacy of financial savings. The sale of IIBs, the first lot on June 4, is as much about ethics as economics: the government should compensate the people for having failed in its duty to control prices.

Once we view IIBs as an entitlement rather than just another economic instrument, it follows that the new bonds should be indexed to the consumer, and not wholesale, price index.

The WPI does not reflect the true extent of inflation. This is borne out by the growing divergence between the WPI and consolidated CPI. The RBI’s May bulletin says, “Since December 2012, inflation as measured by the all-India new Consumer Price Index remained in double digits even as WPI inflation moderated, leading to a widening of the gap between the two. This divergence is on account of several factors. Both the higher weight of food in the new CPI (47.6 per cent) compared with the WPI (24.3 per cent), and higher food inflation in new CPI…contributed to the divergence.”

Besides, services inflation (in education, health and housing), which, like food inflation has been in double digits, is not captured by WPI. It can be argued that even the new CPI does not reflect the true impact of inflation, given that it takes 2010, a high inflation year, as its base.

The argument that the new CPI index is yet to stabilise seems like a weak case for linking IIBs to WPI. If that were the case, why not use the GDP deflator as an interim measure, since that accounts for the services sector as well? The RBI, too, should move to CPI as its inflation anchor at the earliest, so that the IIBs can do the same.

IIBs are, in fact, a good macro-economic idea. Fixed deposits may bounce back when other players offer similar products with attractive features.

Higher real incomes could revive consumer confidence and demand, setting off the growth engines once again. Fearing the deficit impact, the government will be persuaded to set its finances in order. But for these forces to kick in, the inflation peg has got to be right.

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