Supply-side constraints,significant growth in demand for food and a gradual turnaround in the economy are the reasons to blame for the rise in inflation to double digits. At 9.89 per cent,the headline inflation today has breached the annual projected target at 8.5 per cent. But that's not all. This is the wholesale price index number that does not capture the full extent of the price rise we face at the moment. Also,it takes into account a host of items that we do not require or use in our daily lives. If we take into account just the basket of goods that we actually consume,inflation will be much higher than what it appears. High inflation,being a double-edge sword,will not only demand a greater allocation of current resources to take care of daily needs,but will also eat into the returns generated by investments. A right investment portfolio,then,can help you hedge against inflation. Cause The rise in inflation was primarily driven by rise in food prices that was,in turn,due to a substantial increase in demand. Usually,shortage of supply jacks up wholesale prices first and then retail prices follow. However,this time around,the opposite happened. Retail prices started rising earlier than the wholesale ones and,at the moment,it is the retail market that is dictating the prices. Besides,there are limited number of options on the import front as well. India is already the worlds largest importer of pulses. Explains Pronab Sen,chief statistician of India: There is a structural issue here. While the supply has been increasing at almost 3 to 4 per cent every year,the demand side has picked up by more than 7 per cent putting pressure on prices. There is a limit to what we can import. We have to accelerate the production of fruits and vegetables and also develop a good storage and distribution system to counter this problem of rising inflation. While food prices have now been moderating somewhat,prices have started rising in other sectors,which will drive inflation to newer heights. While food prices were stoking inflation earlier,slowly,more worrying factors are emerging. We are seeing a rise in prices of non-food articles like textiles,cement and non-metallic minerals. There are a number of categories that are witnessing a sharp pick-up in demand. This is gradually pushing the headline inflation to double digits, says Abheek Barua,chief economist,HDFC Bank. Outlook With the economy showing signs of a quick turnaround,we are often told by our leaders that we will have to live with high inflation for sometime. I will not be surprised if it (inflation) reaches double digits in March, finance minister Pranab Mukherjee had said. Economists,on the other hand,expect the headline inflation to peak in the middle of the next financial year. It will remain close to 10 per cent in June and then decline,but not too rapidly. By December,we expect the WPI inflation to touch 6 per cent and then come down to 4.5 per cent by the fourth quarter of the 2011 financial year, says Barua. Impact Apart from its direct bearing on the cost of living,inflation has an indirect impact on a host of other things: Interest rates. One of the potent ways to rein in this monster is to use monetary tightening measures. The Reserve Bank of India (RBI) has already launched its first salvo by raising its short-term borrowing and lending rates by 25 basis points each and has said that the measure was intended to anchor inflationary expectations and check price pressures. It raised the reverse repo rate,(rate at which it absorbs excess cash from banks) to 3.5 per cent from 3.25 per cent earlier and the repo rate (rate at which it lends to banks) to 5.0 per cent,from 4.75 per cent earlier,with immediate effect. Barua expects a rise of 75 to 100 basis points in these key interest rates during the next three quarters of the next financial year. Although none of the banks has raised its interest rates yet,industry experts expect these to rise soon. This would translate into high cost of borrowing for different needs like auto loan,personal loan,and home loan. Investments. High inflation means high cost of living and,therefore,depreciating value of money. Also,like taxes,inflation also eats into your real rate of return,thereby eroding your returns. For instance,an investment of Rs 10,000 in a term deposit with a return of 8 per cent will fetch you Rs 10,800 after a year. Now factor in 9 per cent inflation,the real rate of interest dips,making your real rate of return negative. Similarly,keeping your money in a savings account that offers a measly 3.5 per cent return is also counter-productive. Investments in low-risk instruments such as a term deposit,public provident fund,or post office monthly income scheme that give approximately 8 per cent rate of return are also not the best instruments to use to get inflation-protected returns. We have to get used to high rates of inflation. Investing only in debt instruments are likely to compound losses rather than generate wealth for investors, says Surya Bhatia,a Delhi-based financial planner. What should you do? Inflation shadows high growth rate,and in such a scenario,having a balanced portfolio always helps. A sound financial plan built over three to four years can certainly hedge your returns against inflation. While small saving schemes certainly give you assured returns,the returns generated by them (negative in the present scenario) can decrease your purchasing power. Financial planners suggest that there are only two asset classes that have the potential to give you inflation-protected returns: real estate and equities. These two asset classes have the potential to give good positive returns over a longer period and therefore can act as hedge against inflation. An investor can systematically put small amount of money every month in an index fund, says Veer Sardesai,a Pune-based financial planner. Conservative investors can also invest in gold. Everybody cannot invest in real estate. Therefore,investors can stock gold bullion over time, adds Sardesai. Also,with rising costs,you must have a health insurance cover to protect yourself from rising medical costs. The earning member of the family must have a term life insurance cover and then there should be a health cover for everyone in the family. Rising costs can erode your savings in case something unfortunate happens, says Bhatia. Action needed With inflation becoming a part of our lives,government can look at introducing inflation-protected bonds,something on the lines of TIPS (Treasury Inflation Protected Securities) in the US and similar bonds in the UK. These will not only give the investors a more dependable way to invest but also give returns above inflation. We should have instruments like TIPS here as well. It opens up avenues for risk-averse investors, says Barua. Inflation is a ground reality and is likely to be a part of our lives for sometime. Therefore,having a balanced investment portfolio always helps in fighting this monster. u suneeti.ahuja @expressindia.com Buckled under rising inflation The Arya household conditions and their struggle with the rising inflation echo the plight of low- and middle-income group families in India today. This family of six,where four of the members earn,barely manages a total income of Rs 25,000 a month. Anita,25,is the oldest daughter of the four kids of Parvati and Chandhan,and anchors all family expenses. She works as a private secretary at a private hospital in Delhi and contributes the maximum to the household income. It is becoming increasingly difficult for me to manage the expenses. In the last one year,prices of food articles have shot up. Just 12 to 15 months ago,I used to spend Rs 3,000 on groceries and other small items for the house. But now,Ive to keep aside more than Rs 5,000 per month, says Anita. A little more than a year back,the family with almost the same income as today,managed to save anywhere between Rs 3,000 to Rs 5,000 a month. But now,there is barely anything left for them to save. In fact,the family had to break its fixed deposits before maturity to keep the show running at home. Salaries are not rising yet,but inflation is. Fares for public transport have almost doubled,the price of milk and vegetables and sugar is touching new heights. We have already compromised a lot on the quality of food. What else do we do? asks Parvati. Besides this,the family also has pay Rs 6,000 per month as house rent.
