The inflation heat is on for the consumer. The country's food inflation rose to 16.90 per cent for the week ending June 12 (on a year- on-year basis), higher than the previous week's 16.12 per cent, according to the government data released on June 24.
A day later, the Ministry of Petroleum and Natural Gas raised kerosene prices by Rs 3 per litre, petrol by Rs 3.50 per litre and diesel by Rs 2 per litre. Even liquified petroleum gas (LPG) got costlier by Rs 35 per cylinder.
Experts say inflation may see an immediate upward impact of around one percentage point due to fuel price hike. And a growing threat of inflation will mean that the Reserve Bank of India (RBI) is also expected to hike interest rates in the July 27 monetary policy review.
In other words, there will be a hike all across the board, in terms of prices and loan rates. And the worst part, returns from investments will fall. Here's how. The economic meaning of inflation is "general and progressive rise in prices". Which means it continuously affects us.
Let's understand this with an example: The cost of a masala dosa in 1987 was Rs 3.50. In 1997, it costed Rs 14. If the rise in prices continues at the same rate, the dosa would cost Rs 224 in 2017. Similarly, the cost of a Colgate toothpaste in 1987 was Rs 8.05. It was Rs 18.90 in 1997.
At the same rate of progression, we will have to pay Rs 104 in 2017. All of us have witnessed this slow, but steady increase in prices, often wondering if our earnings will be able to bear the burden in the long run.
That's not all, as an individual, there are four pillars of finance: Assets (investments), liabilities (borrowings), income and expenses. And they all get hit by the dreaded 'inflation'.
RETURNS
Assume we are generating returns (in percentage terms) of 6, 20, 12 and 25 from debt, equity, gold and real estate, respectively. If the rate of inflation in the system is 7 per cent, our real rate of return from debt will be (in percentages) minus one, from equity, 13; from gold, 5 and from real estate, 18. Thus, inflation affects all our investments.
During inflation, the rate of interest in the economy rises. Therefore, our rate of interest on borrowing will rise. Consequently, our liabilities increase. At the same time, the value of the rupee depreciates and the basket of goods that can be purchased with the same budget falls dramatically. While we cannot escape inflation, we can try and reduce its impact on us.
For instance, we should invest in assets which can generate returns higher than the rate of inflation. These are equity, gold and real estate. However, these asset classes are highly volatile. So, we should focus on our financial goals. For those likely to take place in the next two to three years, we should invest in debt-based instruments. For long-term financial assets, consider equity, gold, real estate, etc.
As far as possible, avoid borrowing. However, if there is a loan, get out of it as soon as possible.
EXPENSES
Expenses can be tackled. Broadly, there are two categories, mandatory and voluntary. Within each, there are fixed and variable expenses. Mandatory fixed expenses like school fees, house rent, etc. Next, mandatory variable expenses like grocery, medical and healthcare expenses, etc. There is no way to avoid mandatory expenses.
In case of voluntary expenses, again two categories. Voluntary fixed expenses such as gymnasium fees, club membership, etc. Voluntary variable expenses include eating out, vacations, etc. While inflation is rising, we should cut the latter and when renewal time comes for the former, reduce or stop these.
Even after controlling voluntary expenses, if we struggle to make both ends meet, than a step-down process. Such as transport expenses to go to work, a mandatory variable expense. One extreme is to go to work in a chauffeur-driven car. Another extreme is to walk to work. In between are self-driving, car pools, public transport, etc.
Find the most suitable. Invariably, we focus too much on risks which are transparent, like volatility in the equity market, illness in the family, etc. A non-transparent risk like inflation gets ignored. Because we cannot see the impact of inflation on our finances, it does not mean this does not exist. It takes a silent toll.
The writer is a certified financial planner.
