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?

This question is about Inflation-Indexed Bonds (IIBs) in India, which are issued by the Reserve Bank of India (RBI). These bonds aim to protect investors' purchasing power by linking interest and principal payments to a price index.

Statement 1 (Correct): IIBs can potentially reduce the government's borrowing costs, particularly if the market overestimates future inflation. This is because the government compensates investors based on actual inflation, not anticipated inflation.

Statement 2 (Correct): IIBs offer investors a hedge against inflation risk. They provide protection against inflation by paying a fixed coupon rate on the principal, which is adjusted for inflation. This ensures that the real value of the investment is maintained.

Statement 3 (Incorrect): The interest payments and capital gains earned on IIBs are subject to taxation according to prevailing tax regulations. They are not tax-free.

Statement 1 is correct. Statement 2 is correct. Statement 3 is not correct. Hence, only statements 1 and 2 are correct.