Monday, March 20, 2023

CPI-linked bonds emphasize debt stability against rising prices

With inflation at 8.6% in the euro area and 10.2% in Spain at the end of June, many investors are increasingly looking for inflation-linked bonds. Price increases are one of the major headaches for central banks and the main threat to consumption and even the most conservative investments. Although returns on deposits have begun to improve in the heat of monetary normalization, they are still far from covering the rise in prices. In this context, inflation-linked bonds shine their own light.

In 2014, Spain joined Germany, France, the United Kingdom, Italy and the United States with the issuance of debt indexed for inflation. Eight years later, this program of bonds and obligations amounts to ₹71,809.3 million, accounting for 4.9% of the total outstanding state debt, compared to 5.9% in Italy, or 6.5% from France. The redefinition of these titles will be extended until November 2050.

According to the funding programme, it is expected that Spain will issue gross medium and long-term debt of 148,088 million in 2022. Of this amount, Anna Gill, director of the public fixed income team at M&G, estimates that between 6,000 and 8,000 million will be bonds indexed for inflation. At the end of June, about 3,500 million were sold.

The main difference between traditional bonds and inflation-linked ones is that the latter is updated based on rising prices. Thus, an investor who has an inflation-linked bond with 100 euros in his portfolio (the principal is fixed at 100 euros in Spain) and a coupon of 2%, if inflation rises to 10%, will The principal will be adjusted to increase in the same proportion (110 Euro). What remains unchanged is the coupon, but it will be paid on the larger capital. That is, the issuer will be forced to pay more for its debt.

It plays a special role in times when the cost of financing is expected to rise. With central banks raising rates to curb inflation, the cost of selling debt to companies and governments will continue to rise. Treasury, which extended negative returns years ago to the 10-year benchmark, today only reports returns below 0% on three-month bills. Despite these increases at the end of June, the cost of outstanding debt stood at 1.59% near historic lows.

Although costs continue to record very low levels and Spain does not face inflation-indexed debt maturities until November 2023 (6,137.20 million), in recent months some firms have begun to question the effectiveness of this financing strategy. Is. Rating agency Moody’s warned in June that high inflation and a low income base in Spain would hurt debt stability. According to his calculations, inflation-linked debt will worsen debt affordability indicators early this year. In their estimates, they indicate that a one percent increase in prices adds 600 million euros to interest costs. With inflation of between 7-8% at the end of the year, the agency estimates additional costs of more than $4,000 million.

Ignacio Fuertes, investment partner and director at Miraltabank, is more optimistic. Experts agree that refinancing of these instruments is not something that can offset the financial cost of all public debt. This type of issue represents a low percentage of the total debt and the fact that it is not necessary to wait until November 2023 for its refinancing are reasons that will help ease the pressure. “Inflation-indexed bonds are an alternative source of funding, which in particular are not bonds and traditional bills, which gives a better image of the Treasury by putting the instruments into circulation,” Fuertes explains.

shield against rising inflation

Bonus, Unlike traditional debt and floating coupon bonds, these securities offer protection against rising prices, explains Juan Fierro, associate director of the Spain office of Janus Henderson. That is, while traditional assets such as stocks and bonds can be hurt by periods of persistent inflation, value-indexed debt is an effective strategy for incorporating apparent real returns into a portfolio.

Coupons, An inflation-indexed bond carries a fixed coupon. In the case of Treasury-issued bonds, they are linked to the development of the euro area’s consistent inflation rate. The main difference with traditional bonds is its payment structure. Traditional pays a fixed coupon that is calculated as a percentage of the principal, while inflation-indexed pays coupons that are small initially but increase as the principal increases each accrual period.

Nation World News Desk
Nation World News Desk
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