RBI has tried to push the inflation index bonds with additional commission for distribution and doubling the investment limit. But the product has not caught the fancy of investors. Find out why different customer segments shunned the product that is open till 31st March
Reserve Bank of India (RBI) Inflation Indexed National Saving Securities-Cumulative (IINSS-C) is open for subscription till 31st March, but there is no rush from investors. Troubled by muted response from investors, on 26th March, RBI has doubled the investment limit for individuals from Rs5 lakh to Rs10 lakh and increased it by five times for other types of investors (Rs5 lakh to Rs25 lakh). In mid-March, RBI decided to offer an additional incentive of 0.5% on the investment amount to Stock Holding Corporation of India and agency banks that collect subscriptions of Rs100 crore or more by 31st March. It is in addition to the 1% commission to be paid on subscription collections. Is it helping to sell the product?
Recently, Moneylife received an email which states - "I approached my bank Indian Overseas Bank D.G. Branch, Pune 41104. They had received no circular. Then I approached SBI Pune City Branch. They also did not have any information." A visit to Bank of Maharashtra branch last week revealed that they have not been able to make a single sale of the product. An existing bank accountholder still has to go through fresh KYC (know your customer), which can also put off customers. Even the nominee of IINSS-C has to do fresh KYC.
IINSS-C interest rate comprises of two parts - fixed rate (1.5%) and inflation rate based on Consumer Price Index (CPI). IINSS-C could have been a game changer for investors, but as the financial year comes to a close it is clear that the product has flopped. What went wrong? After all, when the product was launched in December 2013 the November CPI was 11.24%. It meant that you could expect to get 12.74% pa assuming inflation stays at the same level. CPI climbed down over last quarter to reach 8.1% in February, which is at 25-month low. It did not help investors as it can mean that IINSS-C returns can go down to 9.6%pa if inflation continues to stay low.
There were three major flaws in the product and the combination of the three issues made the product worse-off. Apathy of banks to sell the product is already mentioned earlier. It could be due to various reasons including competing banking or insurance products to sell. One of the bank managers stated that RBI has given branch staff training by videoconferencing. But, he did not have clarity on the redemption process. According to the bank manager, "The banks would sell and RBI will be the registrar of the holdings. The customer may need to approach RBI for any request of early or final redemption." It means that banks don't have complete product awareness.
The other two reasons for IINSS-C debacle are as follows:
• "Cumulative option: Inflation Index Bonds only has cumulative option with maturity after 10 years. It means customers needing regular flow of income from interest will not subscribe to the product. This includes senior citizens who opt for monthly or quarterly interest payment from bank Fixed Deposits (FD) to survive. A period of 10 years cumulative is a long period for even regular customers. How many people buy 10 year cumulative bank FD even though it will give higher yield than FD paying interest annually? At the time of IINSS-C launch RBI stated that it will come up with non-cumulative option in future, but it has not materialised till now.
• "Taxation: A product is as good as the post-tax returns it can give. Even if the pre-tax returns of IINSS-C can be good, the taxation as per tax slab means it suffers from same tax disadvantages as FD. The interest cannot be treated as capital gains and benefit from "indexation". Those in 20% and 30% tax bracket can still find tax-free bonds offering near 9% pa attractive. The critical issue for those in higher tax bracket and high-net-worth (HNI) individuals will be the taxation on accrued interest.
One drawback with cumulative FDs is that you have to pay tax on the interest that you don't receive in hand. You get the interest only on maturity of the cumulative FD, but tax on the accrued interest is payable for each financial year in which it accrues. This is generally done because bank will deduct 10% TDS on cumulative FD every financial year and it appears on your Form 26AS submitted to Tax authority. Those in higher tax bracket will have to pay the remaining tax liability in the same financial year tax filing. It means you have to pay from your pocket as the interest from cumulative FD will not be given till the end of term.
The same will be an issue with IINSS-C. The government will earn the tax payment on accrued interest without paying you any interest for 10 years. As bonds are issued in the nature of government security, no TDS will be deducted. It means that the person in highest tax bracket will have to pay 30.9% tax on the accrued interest each year without any interest paid by the product for 10 years!
The higher the inflation, the higher the accrued interest and hence more tax will be collected. If the inflation dips, the government will benefit by having to pay lower interest on product maturity.
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