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Local investors have said that iBonds, the inflation-linked retail bonds proposed by the government, might be able to help preserve the purchasing power of local residents. Financial Secretary John Tsang said in his budget speech on February 23 that the government expects the local inflation level to hit 4.5 percent in 2011.

But how will it all work? No one is exactly sure yet although the government has tasked the Hong Kong Monetary Authority (HKMA) to work out a way to implement it. An announcement is expected in the next six months.

According to the government's own estimates taken from the 2011-12 budget, the issuance amount of the iBonds will range from HK$5 billion ($640 million) to HK$10 billion. With a three-year maturity, iBondholders will be paid interest once every six months at a rate linked to inflation over the preceding half-year period. The government hopes that every local applicant can be granted at least HK$10,000 for their investment.

The iBond interest comprises of two components: one is the fixed interest rate based on the yield of the local three-year Exchange Fund Bills, and the other is the variable interest based on the inflation level of the last half-year period. In times of inflation, bondholders will be paid the fixed rate plus the inflation rate of the preceding half-year period. But if the standard trend in the economy is towards deflation, then bondholders will still be assured of their guaranteed payment through the fixed interest rate.

The iBond resembles the US Treasury Inflation-Protected Securities (TIPS), a treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. The TIPS are considered an extremely low-risk investment since they are backed by the US government. And as their par value rises with inflation, as measured by the Consumer Price Index in the country, their interest rate remains fixed also.

The Hong Kong government believes that not only would the addition of iBonds be a new investment tool in which to hedge against inflation, but it can also boost the development of the city's local retail bond market. Meanwhile, the city's low interest rate environment has decreased the attractiveness of conventional fixed-rate bonds to retail investors under the Institutional Bond Issuance Program.

Sally Hung, a retiree who is financing her retirement based on personal savings, said that she is interested in iBonds as a hedge against inflation.

"As the stock market has been volatile lately and interest rate hikes in emerging markets is dampening bond prices, the performance of my stock and bond investments may fluctuate. Therefore I consider iBonds as another investment tool to fight against inflation," Hung told China Daily.

However, she is worried the initial amount of iBonds released to the market will be too small in number to bring about a decent return.

"Given the current volatility of the stock market and the sizzling property market in the city, local investors are cautious about making further stock and property investments. However, I predict that cash-rich retiree investors will be attracted to iBonds as its interest return is better than the Hong Kong dollar or yuan deposits in the local banks," Harris Fraser Investment Research Director Andy Lam told China Daily.

Lam added that the administration should consider increasing the initial iBond subscription amount so that purchasing power can be better preserved.

Billy Mak, an associate professor in the Hong Kong Baptist University Finance and Decision Sciences Department, told China Daily that in addition to higher return yields than bank deposits and bond investments, iBonds are also attractive given that it is free of default risks.

"However, for those retail investors who have accumulated certain investment experience, the iBond investment may not be their cup of tea," Mak said.

China Daily

(HK Edition 04/09/2011 page3)