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Managing the household budget is a tough task under most circumstances. There are always some expenses which creep up stealthily and some that shoot up suddenly. And this ends up eating up a far greater share of the budget than previously estimated. This ultimately ends up impacting some other area of expense. While the latest consumer price index inflation data shows that the retail inflation rate has come down to 4.28 per cent, the lowest in five months, there are fresh worries due to rising crude oil prices. Brent crude has already crossed $71 per barrel. And if it continues its northward journey, things could get worse and burn a serious hole in the household budget of many people.
Oil price spurt: India imports a majority of the crude oil that it uses and hence is always exposed to the changes in the international crude oil prices. After a prolonged period of low prices, the main crude oil producers consisting of the Organisation of Petroleum Exporting Countries (OPEC) and Russia have agreed to production cuts in order to push prices higher leading to a sharp rise in the import bill of Indian oil companies in recent months.
In addition, the prices of petrol and diesel have been deregulated. This means that the oil marketing companies are free to set their own prices. There is no government intervention in the matter and the prices at the petrol pumps are also set each day. Earlier, the price changes were announced at 15-day intervals. This has now been done away with. So, the impact of international price movements is seen quicker than before.
Under the radar: Since fuel is filled after an interval of several days, and for some, after several weeks, the change in prices is often ignored. It could be only at a specific stage that people realise the kind of change that has happened. This kind of inflation, which happens under the radar, is one of the most dangerous parts of the equation. By the time one comes to realise the impact on the budget, the damage is already done.
There is an indirect impact as well: The rise in diesel prices might not seem to impact many households directly, but there are other dangers as well. The main impact comes in the form of higher transportation cost on goods which households use regularly. This cost gets passed on to customers. The biggest impact is seen on food items like vegetables and fruits. Even when wholesale prices fall, there is no corresponding change in retail prices because transport costs ensure that there is a significant difference between the two prices. A look at the inflation for food items is a clear indication of the situation because this is one of the most volatile figures in the entire basket of goods. And it jumps and falls in large measures.
Hidden impact: One of the dangers of inflation is that it is also very difficult to measure for a household. Looking at the retail index numbers means nothing for a normal household because the inflation that they face is completely different. The composition of their consumption basket determines their inflation and this is not going to be similar to that of the consumer price inflation index. At the same time, many areas where households spend large sums like rent, school fees, etc might not be adequately represented in the index numbers. So there is a very good chance that your household inflation is far higher than what the headline numbers suggest.
Budget focus: Tackling these kinds of situations is not very difficult for an individual, but the basic requirement for this is maintaining a tight budget. This is a must for all households. A budget will enable a family to know how much they have to spend on a particular area. A spurt in the price of some item will lead to a cost overrun. But since a budget is being maintained, the family will notice this and be able to take some action, eitherby controlling cost or by allocating more funds to that area.
It is very essential that a contingency amount is set aside in the budget to tackle such price rises. This is essential so that other activities are not disrupted due to a sudden change in the budget. This amount can be around 7-10 per cent of the total budget so that the figure available is adequate to meet the changing situation.
There should also be a close tracking of expenses and prices when one makes purchases because this will bring out the big changes immediately. It will enable prompt action, which in some cases could also be lower consumption. If, for example, there is a consistent rise in petrol prices, one might look at using the car only for essential travel and try and cut back on some part of the use in order to remain within budget.
Continue investing to beat inflation: The key thing in the entire budget exercise is that at no point should expenses eat into the savings element and disrupt the investment plan of the individual. For many people the investment made each month comes after the expenses, so there is a good chance that there might not be any money left to invest. The way to go about this is to make investments a fixed part of the financial exercise and then ensure that total spending is restricted to the amount available.
At the same time, one also needs to have good exposure to different asset classes to ensure that one is able to beat inflation. This means that a traditional debt portfolio will not work any longer. One should try to get the most out of even debt investments through debt-oriented mutual funds. Exposure to equity is also essential in a manner that is suitable to the risk-taking appetite as well as goals of the individual. Trying to create a safe portfolio should be abandoned because equities are the best route to beat inflation.
The writer is a Mumbai-based financial planner