Are you inflation-proof? Tips on weathering the storm

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While the government has the liberty to adopt fiscal measures to protect the nation from inflation and ensure its own survival, consumers are more helpless for they are at the mercy of both the government policies as well as inflation.

But all hope is not lost. Inflation does not mean that your real income will always go down. By keeping in mind the following things, you can insure yourself against inflation. Yes! You can protect your wealth and even prosper during this very difficult period.

[1] First you must understand that inflation means the government has no choice but to adopt measures that devalue the rupee in your pocket. Inflation can be supply side or demand side or both. In any case, the government and the central bank (in collusion) will adopt policies to drain "excess" liquidity from the market. In other words, when "too much money chase too few goods," the government has to restrict the growth in the money supply. This is done by hiking key interest rate, viz. the repo rate, or the key lending rate at which the central bank lends funds to commercial banks, and cash reserve ratio (CRR) or the proportion of reserves the banks must keep with the central bank. When the central bank hikes the repo rate or CRR or both, commercial banks are left with less cash and in turn, are forced to hike prime lending rates (PLR) i.e. the rate at which they lend money to consumers, and also deposit rates. Now when consumers face higher lending rates, they buy fewer goods on credit, which, in turn means, less money end up with shopkeepers and manufacturers. And, with less money, credit and expenditure in the economy, it becomes more difficult to raise prices and wages. And thus, inflation is reduced.

[2] You must also understand that inflation means reduction in your real income. It means what you could buy with Rs.10 yesterday, it will cost you more today. Why? Because of excessive credit growth and money supply in the market. This is where the central bank steps in and hikes repo rate or CRR or both. And, when it does, the commercial banks hike the lending rates. Now, as a rule of thumb, lending rates are significantly higher than the inflation rate. In other words, your investments must earn as much as the PLR or at least more than the inflation rate. Investing money in government bonds or putting it away in fixed deposits may keep your money safe but you will actually be making a loss as they have low returns i.e. their interest rates will be lower than the inflation rate.

So the only way to ensure that your real income is not below the inflation rate is by investing in a fund that assures higher returns.

[3] Stay clear away from the stock market unless you have a big appetite for risks. With inflation rate touching double digit, the Sensex or other indexes are not heading north anytime soon. With inflation heading north, the Indian market is not as attractive as it was to foreign investors. And, with economic growth taking a hit, corporate earnings will suffer. Blue chip stocks may not be blue anymore.

However, if you have patience and are capable of taking risk, then invest in a few infrastructure, metal (including gold), oil, gas, food and power stocks. The prices of these stocks generally remain steady, are among the least affected by inflation and rise over time.

[4] Diversify your investment portfolio. Spread your risks. Keep 20-30 percent of your monthly savings in the liquid form and invest the balance amount regularly in a well-diversified portfolio of equity, short-term debt, real estate, commodities and gold. It will increase your cash inflows and help you reduce the burden of rising prices.

[5] If you are planning your retirement, plan well. Look at annuities that rise in payment, either by a fixed percentage or by retail price index (RPI), as ongoing inflation will erode the value of any future income over the coming years.

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