Inflation up, but you don’t have to panic

Inflation rose for the fifth consecutive week to 5.89 per cent during the week ended June 12, triggering a buzz that interest rates will ris...

Inflation rose for the fifth consecutive week to 5.89 per cent during the week ended June 12, triggering a buzz that interest rates will rise soon. Beyond this jargon is a reality that does impact us. These changes spell the need for a change in our strategies as investors, borrowers and consumers. Some questions that you may want answered:

• Should I worry about rising interest rates and inflation?

Both interest rates and inflation have been at their lowest for many years now. A small rise in either is unlikely to make a big change in anybody’s financial life. It will be good, though, to look at real returns (interest rates minus inflation rates) to evaluate borrowing and lending decisions. As a lender (bank deposit) or debt instrument investor, get into a variable rate product that allows for automatic increases in rates as interest rates rise. As a borrower, get locked into the lowest rate you can find today.

• I have a large variable rate home loan. What will I do?

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Interest rates are unlikely to rise so sharply in the short run so as to upset your finances. Every 0.1 per cent increase in your home loan rate will push up your EMI by just Rs 6 per lakh. So if you have a Rs 20 lakh loan at 6.5 per cent and rates rise by as much as 0.5 per cent, you are looking at an extra EMI of just Rs 600 extra each month. If you are feeling insecure, it may be a good idea to fix the rate now, your bank may even do it without a fee. Those with fixed rates can smile.

• I invest only in bank deposits, what happens to my investments?

As a lender, you will benefit from getting more on the deposits. Deposit rates that had been falling for the last few years had stabilised over the last six months. These may rise soon, increasing your nominal return. Rising inflation could take away this gain. Again, keep looking at the inflation indexed or real return. Don’t expect the rates on the small savings (PPF, Post office deposits) to increase in a hurry. At 8 per cent, they are much higher than what the bank deposits give today.

• I am a retired person, what does this mean for me?

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Rising inflation will hurt the retired people more than any other class, since everybody else earns in current rupees and salaries tend to get inflation-indexed each year. Rising prices will hurt those who live off their investments, especially if the investments are in the risk-free fixed rate instruments like deposits. But rising interest rates may keep the real rate of return steady, nullifying the impact of the price rise, keeping the purchasing power intact.

• I invest in bonds and bond mutual funds. Will all of them tank?

It is true that as interest rates rise, bond prices fall, causing a capital loss. We experienced the opposite two years back, when falling interest rates gave our debt funds big gains. The reverse can happen when rates rise. Not all bond funds will react the same way. The longer the tenure of the bond fund, the larger will be the impact of an interest rate rise and the worse will be a long term bond fund’s performance. This is not the time to begin investing in debt funds. Those holding should make a tactical shift to a short term fund or a floating rate fund.

• Should I sell my banking stocks now?

Banking experts internationally maintain that interest rate increases are good for bank bottomlines, as not all the interest rate hike rise is passed on to the deposit holders. Those banks with a large retail presence may benefit while those with fixed rate loans will suffer. With banking stocks plunging, this may be a good time, for direct equity investors, to do some value picking in the sector.