Explained: How inflation impacts households, and what to do with your savings

“In the sequence of priorities, we have now put inflation before growth. Time is appropriate to prioritise inflation ahead of growth,” RBI Governor Shaktikanta Das said after unveiling the bi-monthly Policy Review.

Impact on households

The high inflation has been driven by rise in prices of fuel and food items such as cereals and vegetables. Rising fuel and food prices not only directly impact the household budget of families that are slowly coming out of the shadow of Covid, but also threatens to put them under further pressure on account of the expected rise in interest rates in the economy.

A rise in interest rates, as indicated by the RBI and in line with the global trend across central banks, will have a major impact on large section of the society that are paying EMIs on home loans.

While the interest rate hike in India is not expected to be very sharp compared to what has been planned by the Federal Reserve in the US, it will have a bearing on existing loan customers.

If the rates were to go up by 100 basis points from 7.5% to 8.5% over the next one year, the EMI on a principal outstanding of Rs 50 lakh for 15 years will go up from Rs 46,350 to Rs 49,236 – a jump of Rs 2,886 a month — if the tenure were kept constant. If the interest rates were to go up to 9% — a 150-basis-point increase — the EMI would rise to Rs 50,713, an increase of Rs 4,362 per month.

Impact on investors

A low-interest-rate environment also impacts conservative debt investors who are more comfortable investing in fixed deposits and other safe assets. When rates are low, most fixed deposits have been earning an interest rate between 4.5-6% for investors depending on tenure; however, as a result of the high inflation, the real interest earning has been negative. For those in the highest tax bracket, it even makes less sense to invest in fixed deposits as the post-tax-return would stand between 3.1-4.1%, which is significantly lower than the inflation rate of 7%.

If the fixed deposit or a small savings instrument is earning 6% when inflation is 7%, then on a net basis the real interest income is negative (nominal interest rate minus inflation). Most of the small savings schemes, too, are now generating negative real rate of interest; only PPF (7.1%) and Sukanya Samriddhi Yojana (7.6%) are generating an interest income that is higher than the inflation rate now.

Even the Central Board of Trustees of the Employees’ Provident Fund Organisation (EPFO) recently recommended a cut in interest rates from 8.5% to 8.10% for its over 6 crore active subscribers for 2021-22. The post-tax return of 8.1% is the lowest interest rate on EPF in at least four decades, but it is still higher than rates offered on small-saving schemes or on any other debt instrument including bank fixed deposits.

What you should do

Any financial instrument must serve the purpose of growing your money — so, the first thing one must see before putting money in a pure debt instrument is whether that is happening.

With inflation expected to rise further in the wake of the ongoing war and other global and domestic factors, investors needs to ensure their savings earn higher return than the inflation rate. As of now, any income less than 7% net after taxes actually makes you lose money.

In fact, in a rising inflation scenario, if your investments can’t earn above inflation, it is better to spend it today than save for tomorrow, because a year later, its value would be lower. So, as inflation continues to reduce your savings, there is no way debt instruments will help you beat inflation.

Financial advisors say conservative investors will have to bring equity into their portfolio in some form, be ready to carry some risk, and live with some volatility. “Investors need to improve their basket of asset allocation and will have to consider mutual fund offerings such as conservative debt hybrid, balanced advantage funds and equity savings schemes (that invest in equity, debt and arbitrage securities). Investors need to understand that higher returns can only come from equities and it also leads to better tax management,” said Surya Bhatia, founder, AM Unicorn Professional Pvt Ltd.

While investors can also look at some company deposits offering relatively higher interest, they need to first seek professional advice and weigh their credit rating and risk.

Those who still want to stick with pure debt products should go for short-duration products because, as interest rates rise with rising inflation, they will be able to take advantage of these higher rates.

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