Avoid risks, cut expenses

In a high inflation and low returns scenario, it makes sense to play safe.

The Indian household has been facing the brunt of high interest rates and inflation for some time. The Reserve Bank of India’s battle with inflation has led to a sharp rise in interest rates. Over the last 15 months, it has raised indicative rates — repo and reverse repo — 10 times. At 9.06 per cent in May, the consumer price index continues to hurt.

The latest increase in the prices of diesel, kerosene and liquefied petroleum gas (LPG) to Rs 41.12 a litre, Rs 14.83 a litre and Rs 50 a cylinder, respectively, will only worsen things for the Indian household.

The new rates will impact almost everyone. “Given the 50 per cent correlation between fuel price inflation and core inflation, the second round effect on non-fuel items will be significant, with the headline inflation metric for July possibly returning to the double-digit territory” warns Ritika Mankar, economist at Ambit Capital.

Together, LPG, kerosene and diesel have a weightage of 7.4 per cent in the wholesale price index (WPI). According to a report by Macquarie, the current rise in prices is expected to increase inflation levels by another 70 basis points.

Debt investments: Raising interest rates to curtail inflation is generally good news for the debt market. However, with the rates yet to catch up with inflation, most debt funds have not been able to give real returns.

Fixed deposits, bonds and public provident fund (PPF) are safe investment options for now. However, even as they minimise the wealth-eroding effect of inflation, they do not really beat it, believes Rajeev Thakkar, CEO, Parag Parekh Financial Advisory Services.

Investments: The Sensex isn’t giving much comfort either. Last October, there was sense of relief when it hit the 22,000-mark. But, over the last eight months, it has dropped to the current level of 18,000 points.

According to economists, a high-inflation scenario dampens the market sentiment significantly. Over the last decade, the Sensex has given average returns of 0.8 per cent during times when inflation crossed five per cent. When the latter has been low, the average monthly returns, at 2.9 per cent, have been substantially higher.

You are indeed sitting on pots of money if you invested way back in 2003, when the Sensex was at 3,000 points. However, if you had invested a lump sum in January 2008, you are more likely to be counting losses. Also, once inflation comes into play, the real returns from investments in Nifty, large-cap and mid-cap funds and 10-year government securities (G-secs) would be negative. (Though one cannot invest in G-secs directly, it is used as a benchmark for debt instruments.)

What to do: In such times, it is a tough call for consumers and investors alike. If one were to go by the Nielson Global Consumer Confidence Index, thriftiness is in. The report showed 72 per cent of Indians have changed spending habits to curtail household expenses.

A good percentage of the respondents said they would cut on expenses such as home entertainment, telephone expenses and holidays. The index also pointed out that 51 per cent of Indians surveyed said they spent less on buying clothes now.

Experts say liabilities like equated monthly instalments (EMI), bills, maintenance, etc, should be paid off as quickly as possible. One could sell low-yielding assets, whose returns are lower than the EMI interest rates, to pay off existing loans.

While one can’t do away with fixed expenses like school fee, insurance premiums, etc, variable ones like travelling and eating out can be curtailed with a step-down strategy. Another idea catching on is pooling a car, instead of travelling to work alone. This can reduce travel expenses by 25 per cent.

As far as investing goes, the only alternative left is the ‘bottom-up’ stock picking approach that compares the company’s fundamentals vis-à-vis market valuations, says Thakkar.