There is a real possibility of inflation accelerating from here on in India. The country is now in the middle of a high-risk monetary experiment. Last week, the Reserve Bank of India announced plans to buy government or treasury bonds from the secondary market. This is an indirect means for RBI to fund the government borrowing programme. This is deficit monetisation and money printing on the sly.
India’s central bank is doing this with the sole purpose of keeping the interest on government bonds or bond yields anchored at the current level of around 6 percent. It has so far succeeded in its endeavor. The yield on 10-year Government of India bonds declined by nearly 20 basis points after the policy announcement by the RBI governor.
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The suppression in the bond yields has however come at the cost of rupee exchange rate. The Indian rupee has lost nearly 2.5 percent of its purchasing power against the US dollar since the policy announcement. Rupee closed Tuesday with an exchange rate of Rs 75.13 for an USD against Rs 73.20 prior to the policy.
If the RBI continues to insist on lower bond yield, it could start a vicious cycle of currency depreciation, higher input cost and higher inflation that again leads to currency depreciation and so on.
Free and open trade blunts the chances of product inflation in a particular country as cheaper goods can be imported if domestic prices rise too fast.
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In the post pandemic period, however, the Indian government is discouraging imports through various tariff and non-tariff barriers. This has the potential to lead to an even higher inflation due to a persistent rise in money supply in India.
High inflation is bad for everyone but it will specifically hurt savers and investors. The biggest losers will be those that largely invest in fixed income instruments such as bank and post office deposits.
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Here’s what you can do to minimise the impact of inflation on your pocket and investment.
1. Complete all heavy duty construction or renovation work in your house. This is an odd suggestion when talking about inflation but it’s important considering the potential rise in construction cost in a high inflation scenario.
If you are planning to construct a new house or doing an extensive renovation in your existing house, then complete your project as early as possible. Inflation always hits construction materials such as cement, steel, bricks, aluminum, timber and tiles first. This is because construction materials are most often highly energy-intensive. Their prices move very fast when currency starts depreciating and that, in turn, pushes-up energy and fuel prices. Cement, metal and timber prices are already up and they could rise further.
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Lastly, inflation is good for physical assets as it increases their price. So higher inflation in future will translate into higher price for your completed or refurbished house in future and will act as a store of value for your wealth.
2. Start accumulating gold & silver. Historically precious metals have been a good hedge against inflation and this is not surprising given that both the metals are priced in dollars rather than Indian rupee. In other words, if the rupee continues to lose its purchasing power against hard currencies like the dollar, gold and silver prices will go up in rupees.
I am advocating both precious metals because of two factors. Firstly, while both the metals do well during inflation, they don’t necessarily follow the same price trajectory. An investment in both the metals provides diversification as a hedge against wild movement in either of the commodities.
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The white metal being cheaper can act more as a currency in times of high inflation than gold. So you must always have silver worth a few months of your expenses in your portfolio right now.
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Lastly it is advisable to invest in physical gold and silver given the turmoil in the financial markets than paper metals in the form of exchange traded funds (ETF).
3. Stay invested in equity by rejigging your portfolio in favor of companies that will gain the most from high inflation. In general, high inflation is bad for equities as an asset class, but not all companies will be equally impacted by it.
The maximum gains will accrue to top companies in sectors with high market concentration or oligopoly like situations such as steel, aluminum, petrochemicals & synthetic fibres and cement. Power and gas companies may also do well as their product prices are regulated and determined on a cost-plus basis.
This has already begun to play out. The BSE Metal index, which tracks the share price and market capitalisation of top ten metal & mining companies such as Tata Steel, JSW Steel, Hindalco, Coal India, NMDC and Hindustan Zinc among others, is up around 33 percent since the beginning of January this year against around 8 percent rally in BSE500 Index during the period.
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Similarly, cement stocks have out-performed the broader market in the last three-months. This divergence is expected to widen further as inflation takes hold.
4. Go light on banks, financial services and insurance stocks. High Inflation will be most detrimental to banks, insurance and financial services (BFSI) companies who deal in paper-assets or securities rather than physical assets or goods. The sector will also get hit from a sharp depreciation in the Indian rupee against hard currencies. This may be counter intuitive for many equity investors as BFSI stocks have 35 percent weightage in the benchmark indices and they determine the move in the broader market.
Large BFSI stocks are the first port of call for stock traders and investors given huge liquidity and trading volume in these counters. But I will advise equity investors and traders to go underweight on this sector if it’s impossible to avoid them given their sheer size in your portfolio.
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5. Have some amount of loan on your books even if you have the cash to repay it and become debt-free. Inflation usually involves a transfer of wealth or purchasing power from a creditor (or debtee) to the debtor. This is because it lowers the purchasing power of currency over time. In other words, a principal or loan amount of say Rs 10 lakh is worth more today than in future. This way inflation allows borrowers to pay lenders back with money that will buy less goods and services than was when they originally borrowed. This is the origin of the concept of inflation tax which allows the government to inflate away the debt owed to their citizens.
So if your balance sheet allows it, borrow some money from banks and invest in physical assets such as a house or land including agricultural land.
(Advice: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making deposits or investment in any of the banks, funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
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