You must have read how April CPI inflation quickened to 4.58 per cent year-on-year. The number was above most estimates put out by economists, and higher than the 4.4 per cent consensus. Inflation is always countered by raising interest rates. Rising prices may mean good news for companies, which can pass off price hikes and protect margins. For the common consumer and the Indian investor, inflation poses different problems. Let us try and understand how you should go about managing your money if the Reserve Bank hikes interest rates due to inflation.
As of now headline CPI looks contained, but core CPI is at the above 5 per cent handle. With crude oil and other commodities firming up recently, many experts reckon that it will be difficult for headline CPI to sustain at the 4 per cent anchor. Latest WPI inflation print has surprised on higher side too. It is important to note that February WPI saw a sharp revision from 2.48 per cent to 2.74 per cent, thereby hinting at supply-side inflation pressure.
Going forward, the impact of MSP hike, further pass through of imported inflation (as currency has also depreciated further) and higher crude prices will keep the pressure on inflation elevated. Among sub-components, price pressures were elevated across almost all segments – clothing, household goods & services, health, recreation, education and personal care.
The Reserve Bank of India is unlikely to be comfortable with the firm core inflation. There has also been higher volatility in the bond and exchange rate markets. These factors validate many experts' expectations for the RBI policy committee to veer towards a hawkish stance in June. While there is a small probability of a pre-emptive hike, at the moment the money is on RBI paving the way for a + 25 basis point hike in August. Thankfully, slow progress on the banks’ bad asset resolution and a gradual turnaround in growth suggest that an aggressive hiking cycle is unlikely at the moment.
Rate hike means
Gilt funds - These products invest all of their money in government securities. They have been under pressure for various reasons. G-sec yields have hardened significantly in recent months. So, further upside in response to RBI rate hikes will be limited. Plus, RBI's OMO purchases, to infuse durable liquidity into the system, will ease the pressure on yields and reduce the volatility in bond market going forward. Expect 10-year G-sec benchmark to trade between 7.60 per cent and 8.10 per cent band in medium term. One can expect the yield to inch towards 7.9 per cent, before breaching 8 per cent. The shorter-tenor bonds are increasingly factoring in the likelihood of a tighter policy stance.
Equity funds - The only truly direct effect of a rate hike is that it becomes more expensive for banks to borrow money from the RBI. Do note that increases in the interest rate have a ripple effect. Because it costs banks more to borrow money, financial institutions often increase the rates they charge their customers to borrow money. Shares of rate-sensitive sectors like banks and NBFCs may see pressure. Also, do keep a watch on lending-related sectors real estate, and consumer durables. Funds have invested in such sectors will have to brace for impact if a rate hike is delivered in the next three months.
Bank FDs - Periods of rising interest rates are often associated with volatile stock and bond markets. Hence, many often say that the case for becoming more defensive is good. Higher lending rates do not immediately mean higher deposit rates. Before you sell up and return to cash, we need to recognise whether rising rates in India would be a sign of economic progress or not. If a rate hike also signifies good tidings for the economy, it might be foolish to ignore stocks and shift to bank FDs. To understand, one must read about the macro data and be convinced whether the rate hike is a result of a growing economy or simply due to rising prices not connected with GDP growth.