How to beat inflation risk :: Business Line

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Life is difficult for investors. On the one hand, deposit rates are set to decline as a consequence of the recent 0.50 per cent cut in the repo rate by RBI. On the other hand, food inflation is still high.

Throw in the fact that the growth in the Indian economy is slow and you have a not-so-optimistic scenario ahead! The question is: How should you protect your cash flows in light of the declining interest rates and high inflation condition? In this article, we show why you should be concerned about inflation and how you can moderate your inflation risk.

Your current income has to meet two responsibilities. One, it has to support your current standard of living. And two, it has to supplement your future standard of living! This happens when you save a part of your current income and invest it for future consumption.

TWO-FOLD PROBLEM

The problem with investing for future consumption is two-fold. One, rising inflation could defeat your objective of accumulating wealth to meet future consumption. Suppose you want to invest for 10 years to meet your daughter's college expenses. If rising inflation pushes up education costs 10 years later, you may be unable to fund your child's education solely with the investment that you created for the purpose.

The problem is compounded when you consider that health-care costs and education costs typically rise much more than the general price levels in the economy. Besides, there are two other factors that you should keep in mind. One, interest rates on your bank deposits may be lower than the inflation on products that are relevant to your lifestyle requirement. And two, you do not have products that protect you from rising inflation. The US market offers Treasury Inflation Protection Securities (TIPS), where cash flow from the investment is adjusted to compensate for any increase in price levels in the future. Unfortunately, such products are not available in India at present. So, what then is your course of action?

INFLATION INVESTMENTS

You have to adopt two strategies to moderate your inflation risk. First, invest in commodities. This would help if inflation is due to rising costs. An increase in iron ore, for instance, will increase steel prices, which in turn, would result in higher automobile prices. You can buy certain commodities such as gold, silver and copper in the electronic form through National Spot Exchange Limited (NSEL). You can also invest in Gold ETFs and commodity futures. We suggest you trade in commodity derivatives only if you can handle the associated risks. Otherwise, you should prefer investments in e-commodities.

Second, your asset allocation policy should be based on inflation-adjusted investment objectives.

Suppose you propose to send you child to the US for college. And suppose college education at current cost is Rs 65 lakh. If your child is likely to enter college 10 years later, you should invest today to achieve Rs 1.69 crore (Rs 65 lakh times the inflation at 10 per cent a year for 10 years). That way, you will be able to fund your child's college education as long as inflation stays within 10 per cent a year and your investment generates the required return.

There is another possibility. If you propose to send your child to the US for higher studies, you can systematically invest in TIPS. This facility is available to you, as individuals in India are allowed to invest abroad up to $2,00,000 every year.

CONCLUSION

You have to be concerned with inflation, as rising price levels can upset your lifestyle consumption in the future. We believe that our markets will see a gradual introduction of inflation-hedge products. Till then, you should invest in commodities and adjust your investment objectives to brace for a high-inflation scenario.