Of Inflation, Interest Rates And Real Returns

Rising interest rates and easing inflation have made things better than earlier; irrespective of the variables like returns on investments, the basics of your investment portfolio remain the same investment strategy.

In the Moneywise article dated July 25, 2021, ‘Inflation isn’t in your control, so worry not’, we had mentioned that your returns on investments should ideally be higher than inflation so that it preserves the value.

However, if it is not so, you cannot do much, because inflation is not in your control. What is in your control is your investments, and it is not reasonable to take higher risks than what suits you, just to beat inflation.

Moreover, the inflation data that we react to, is one data point across 140 crore people, whereas everybody’s consumption basket is unique.

Present scenario

Cut back to present. The situation has improved palpably, and is expected to improve further. In the pandemic phase of 2020, and to an extent in 2021 as well, the Reserve Bank of India (RBI) had kept interest rates on the lower side.

This was done to support the economy, which was hit by lockdowns, global growth slowdown and supply chain disruptions.

The rationale is, when interest rates are low, people are induced to take loans, which are used for some kind of activity which moves the wheels of the economy.

Interest rates are signalled by the RBI through a rate called repo rate, which was reduced to all-time low of 4%. Now that things have normalised, RBI is normalising the interest rates. The repo rate was increased by 2.25% to 6.25% till the review on December 7, 2022. The next review meeting is round the corner, scheduled for February 8, 2023, and there is a possibility of repo rate being increased to 6.5%. Subsequent to the RBI signalling increasing interest rates through an increase in repo rate, interest rates on deposit products have moved up.

A one-year deposit with the State Bank of India (SBI) offers 6.75% for regular deposits and 7.25% for senior citizens. There are other banks offering higher rates of return.

Small savings rates, popularly known as post office schemes, have been increased for the quarter January to March 2023.

One-year Time Deposit rate is now 6.6% from 5.5% earlier. Senior Citizens Savings Scheme now yields 8% against 7.6% earlier. Monthly Income Scheme rate has been pushed up to 7.1% from 6.7%.

On the other hand, inflation has eased. In 2020, average consumer inflation was 6.63% due to supply side disruptions.

In 2021, inflation eased as the base for computation of inflation in 2021 i.e. inflation in 2020, was high. In 2021, consumer inflation averaged 5.14%.

However, average inflation in 2022 was 6.70%. Then, how are we saying that inflation has eased? In April 2022, CPI inflation was 7.79%. In December 2022, it had eased to 5.72%.

Moreover, as per RBI projections, consumer inflation is expected to average 5.8% in January to March 2023 and ease further to 5% in April to June 2023. That is, from the high point of 7.79% in April 2022, it had eased to 5.72% in December 2022 and is expected to ease further to 5% by June 2023.

Going by the recent data points and projections, real returns on deposits have become positive.

Fresh deposits

What should be your strategy? If you want to optimise on the relatively higher deposit rates available now, obviously fresh deposits will be at a higher rate than a year or two ago.

If you are thinking of exiting earlier deposits at lower rates and move on to relatively higher rates, you have to look at two aspects.

One, whether the existing one is liquid or there is any condition for withdrawal. Two, if there is any premature withdrawal penalty — in that case it may not be optimal to shift. Irrespective of the variables like return on your investments, and inflation data prints, the basics of constructing your investment portfolio remain the same. The primary aspects on which your investment portfolio should be based are your investment objectives, financial goals, time horizon, risk appetite and the risk-return profile of the investments.

Your portfolio allocation should not be distorted by inflation data.

As an illustration, if your appropriate portfolio allocation is 60% equity and 40% debt, it should not be 100% equity when inflation is high.

If you have the risk appetite for 100% equity in your portfolio, it should be 100% any which way, even when inflation is low. What is in your control is your investment portfolio. That should be based on proper, logical criteria that you are clear about.

Source: https://www.thehindubusinessline.com/portfolio/personal-finance/of-inflation-interest-rates-and-real-returns/article66477194.ece

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