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?

Answer: A. Statements 1 and 2 are correct; statement 3 is wrong. Inflation-Indexed Bonds (IIBs) are debt securities whose principal and/or coupon is adjusted for inflation. India issued IIBs in 2013-14 linked to WPI initially, then CPI. Statement 1 is CORRECT. IIBs allow the government to REDUCE COUPON RATES because they transfer the inflation risk to the government and away from the investor. Conventional bonds carry an inflation premium in the coupon to compensate investors for inflation uncertainty. IIBs strip out this premium, so the coupon can be lower (since the principal/coupon will be inflation-adjusted automatically). Statement 2 is CORRECT. IIBs PROTECT INVESTORS from inflation uncertainty by adjusting principal and coupon to inflation indices, guaranteeing real returns. This is precisely their selling point to retail and institutional investors. Statement 3 is WRONG. Interest and capital gains from IIBs are TAXABLE under the Income Tax Act. There is NO tax exemption specifically for IIBs. The inflation indexation does provide some tax shield on principal in the long term but the bonds themselves are not tax-exempt instruments. Source: RBI documentation on IIBs / Ministry of Finance gilt market communications.