ET Wealth | Are you ready for surge in inflation? | Economic Times

The inflation monster, dormant for the last few years, is rearing its ugly head again. As the economy gets back on its feet, inflation seems primed to tag along and spoil the party. Recent price uptick in metals and fuel, along with power, took wholesale inflation to a high of 12.94% in May. Consumer price inflation also shot up to 6.3%, compared to 4.3% in the previous month.Prices of essential commodities are rising at a fast clip and eating into the purchasing power of consumers. Cooking oils and pulses are particularly dear. Last month, the average retail price of packed edible oils soared to the highest in over a decade. The monthly average retail price of sunflower oil (packed) stands at Rs 174 per kg—56% higher than a year ago. Prices of tur (arhar) dal and chana dal have also risen sharply over the past year. At a time when many households are consuming more food in the current work- and study from-home environment, the rising prices are stretching kitchen budgets.Both wholesale and retail prices have shot up 83660310In Mumbai, 34-year-old Akanksha Mishra has seen her weekly spend on vegetables double from Rs 300-400 to Rs 600-800. During the lockdown, her monthly household spend on food jumped from Rs 6,000 to Rs 10,000. Like her, many have seen a shakeup in their usual consumption basket amid covid-driven realities.It is time for everyone to confront this reality. If inflation surges, household budgets will go out of whack. It will steadily gnaw away at your purchasing power and eat into investment returns. But you can tackle it better by being prepared.Why to expect rising inflationThere are several reasons why inflation is likely to become entrenched in the near term. The commodity reflation trend playing out over the past few months is not likely to slow down. Brent crude prices crossed $70 per barrel in recent weeks, more than double of what it was a year ago. In India, the price of petrol is already over Rs 100 per litre in places. Prices of base metals have also surged. Global economic recovery and resumption of manufacturing activity will keep prices of key metals on the boil.Edible oils and fuel are among the main culprits behind price uptick 83660407Global inflation creeps into emerging economies through commodities. Higher commodity prices eventually reflect in items of daily consumption, albeit with a lag. Higher fuel prices will show up as heightened transportation costs. Elevated prices of commodities that serve as raw material for manufacturers will find their way into prices of consumer goods. While producers are currently bearing the burden of rising input costs, these can get easily get passed on to consumers as demand revives, finds CRISIL Research. The pandemic has spread to hitherto untouched smaller towns and villages. The resulting disruptions may harm farm output and send food prices soaring.Global commodities have been on the boil 83660415Further, central banks worldwide seem hesitant to rein in the easy money conditions they have persisted with for years. Developed countries have unleashed a tidal wave of liquidity to combat covid-led contraction in economic activity. The stance of the US Fed has shifted to tolerate higher inflation. “Central banks are not in a hurry to take the foot off the gas pedal. In the battle between inflation and growth, policy is clearly gravitating towards reviving growth,” says Ankur Maheshwari, CEO, Wealth Management, Equirus Capital. But many argue this will come at a steep cost. Already, consumer inflation has touched 5% threshold in the US—for the second time in 30 years. Sankaran Naren, CIO and Executive Director, ICICI Prudential Mutual Fund, argues, “With the amount of money being printed globally, you can’t just wish away inflation. Until recently, this money went into assets, but post-covid it is seeping into commodities and goods.”The RBI has been striving to keep retail inflation below its 6% tolerance threshold. Its comfort zone has now been breached. But the RBI will continue to ignore it for now as supporting growth is priority. This is likely to give more rope to inflation.How to stay aheadIf inflation digs in its heels, it will take a larger bite out of your savings. When inflation rises, the purchasing power of money comes down and over time, inflation eats into the returns any asset generates. Your priority then is to ensure that your money grows faster than inflation or at least keeps your purchasing power intact. Here are a few pointers on what you should do now:Recalibrate budgetRising inflation will first send your household budget haywire. The amount you earmark for monthly spend on necessities and discretionary items will prove insufficient. The first step is to get a tighter grip on your expenses. Raj Khosla, Founder and MD, MyMoneyMantra, suggests a workaround: “Figure out how you can cover monthly expenses living off only 70% of your monthly income.” This will help in realigning your consumption and build a cushion against rising prices.It is crucial to get a fix on your own inflation rate. The headline inflation numbers can be misleading. Even if headline numbers suggest inflation is 6%, it may be actually much higher for you. This is because inflation is personal, driven by consumption habits particular to each household. Monitoring your personal rate and identifying the high inflation areas can help put a lid on lifestyle inflation. Besides, inflation rate is a key input in the financial planning exercise. It forms the basis for estimating certain big-ticket expenses in future and identifying the investment needed to fund those. If actual inflation turns out to be even 1-2% higher than estimate, it can jeopardise goals.Your inflation is not my inflationActual inflation rate can vary widely as consumption baskets or spending patterns of households can differ vastly from one to the other. 83660489Review outstanding loansIf interest rates trend upwards in the near term, you may want to review your existing loans. Some lenders have already hiked rates. For instance, SBI restored minimum home loan rates to 6.95% from 1 April, withdrawing its limited period offer of 6.7%. Others may follow suit. When rates rise, banks typically extend the loan tenure rather than hike the EMI. This stretches your total interest outgo. If saddled with debt, try and reduce the outstanding through partial prepayments before rates rise. “Your first priority should be to pay back as much of existing loans as you can afford to,” says Khosla. This will keep interest outgo in check should loans get repriced upwards. Consider liquidating low-yield investments to fund repayments.Even a 0.5% difference in rate can lead to big savings in interest outgo 83660512If paying off a higher cost loan, it may be a good idea to move it lower on the interest ladder. Amid sliding interest rates over the past few years, home loan rates fell to historic lows. However, not all borrowers benefitted. Those still on older rates with many years of repayment left should consider a balance transfer to another lender. Ensure the potential savings on interest outgo are higher than the processing fee charged by the new lender. Those paying off multiple loans may consider consolidating into a single loan with lower interest charge.Maintain allocation to equitiesFinancial planners say equities remain the best answer to inflation. Maheshwari asserts, “Equities have the ability to counter inflation over the long run. Investors must incrementally look to build risk in portfolio to fetch real rate of return.” Experts find echoes of the 2003-08 corporate earnings upcycle in the turning interest rate and inflation scenario today. This multi-year uptick occurred in the aftermath of bottoming out of interest rates and pick up in inflation. “Companies are able to borrow at very low rates at the turn of the cycle and generate high double-digit return on capital in the following years,” explains Kirtan Shah, Founder and CEO, SRE Wealth. 83660575Higher oil prices are also not necessarily negative for the stock markets. On the contrary, Indian stocks have performed well in times of higher oil prices. “Sovereign wealth funds originating in oil-producing nations have surpluses to invest at such times. These make their way into strategic and long term stakes in many companies,” says Mayank Khemka, CIO India, Deutsche Bank.During times of inflation, investors typically gravitate towards larger businesses— perceived to have the pricing power to pass on higher input costs to consumers. But it may not be the right approach, feels Feroze Azeez, Deputy CEO, Anand Rathi Wealth Management. “Don’t rush to large caps at the first signs of inflation. Many mid-caps will remain agnostic to inflation driven capital outflows as this basket doesn’t have high participation from foreign investors.” His advice? Investors maintain 30% exposure to this segment.At a broader level, rise in input costs will impact margins of many companies. “With the uncertainty in demand environment, it will be challenging for companies to pass on rise in commodity costs,” remark analysts at Motilal Oswal. Auto, consumer staples and durables would be highly impacted in such a scenario. More importantly, the uptick in inflation could signal the end of the monetary easing cycle, which has kept funding cost low for businesses and contributed to healthy margins.However, a section of India Inc should thrive in this environment. Metals and oil and gas sectors (upstream companies) will continue to benefit. Motilal Oswal analysts believe metal companies are likely to see superior profitability in 2021-22, which would drive sharp reduction in leverage. Among steel companies, SAIL is more sensitive to steel prices. In the non-ferrous space, Nalco and Vedanta are the biggest beneficiaries of higher aluminium prices.Kotak Securities prefers GAIL over upstream oil PSUs as a hedge against higher crude prices as it benefits from an increase in profitability of LPG production and LNG marketing segments. The brokerage wants investors to avoid ONGC and OIL as a play on crude prices, despite its higher direct leverage on their profits. This is due to an uninspiring production track record amid sustained increase in expenditure, limited free cash flow generation and deteriorating returns due to inefficient capital allocation. Mutual fund investors can participate in this space by investing in select thematic funds like DSP Natural Resources and New Energy, Tata Resources and Energy or ICICI Prudential Commodities Fund.Take gold exposureOver the years, gold has preserved its purchasing power. Unlike currencies, gold cannot be printed and so remains far less susceptible to government manipulation. Even as fiat currencies have lost value, gold has remained a stable store of value.In the present negative real yield environment, the confidence in fiat currencies is likely to be low. For instance, the US 10-year Treasury bill currently yields 1.44%—lower than expected inflation rate. So a long-term investor in US treasuries is almost guaranteed to lose a small amount of purchasing power over the life of the bond. This makes holding gold a more viable option.Gold is a hedge against inflation over long term 83660647Hitesh Jain, Lead Analyst – Institutional Equities, YES Securities insists that rising inflationary trends should be conducive for gold. “Despite rising inflationary trend, Fed is not keen on normalising monetary policy for some time. As a result, we will likely live with a weak dollar and ringfenced US 10 year yields—yet another narrative of negative real yields that will work for gold.” Experts insist 10-15% allocation to gold is always a good strategy. Any investment in the precious metal should be in the form of paper gold.Invest in floating rate bondsThe fixed income part of the portfolio struggles amid inflation. Rising inflation pushes interest rates higher, pulling down prices of longer tenure bonds. Fixed deposits gradually lose purchasing power as real interest rates turn negative. However, there are better alternatives in this space.Stay invested in shorter duration debt funds, particularly those aligned to accrual strategy. These will not be exposed to capital depreciation if interest rates rise, and will benefit from rising coupons. The ideal bets are floating rate bonds. These are bonds where the interest rate is pegged to a reference benchmark rate. With every change in the benchmark rate, the rate on the floating rate bond also changes. Shah remarks, “In a rising interest rate scenario, the floating rate bonds will adjust their coupons upwards and so the fund will be able to capture higher yields.”Years ago, fixed income investors could take recourse to inflation indexed bonds. However, these are not sold in the market today. A close proxy is RBI floating rate bonds. Interest rate (currently at 7.15%) is arrived at by adding 0.35% to the prevailing NSC rate, which is reviewed every quarter as per prevailing yields on government securities. However, rate transmission can be erratic as the government may not always realign rate as per formula.