The Hindu Business Line : Inflation worries

If there has been any pet `worry story' for this season, it is inflation. If the Reserve Bank of India and the Ministry of Finance are worrying about inflation, need it be said that you as an investor or consumer should certainly worry about it too!

First, a quick recap of the latest move that reflected the RBI's concern on the above issue — the cash reserve ratio (the amount of money that a bank has to park with the RBI) was hiked to 6 per cent by the RBI late Tuesday. This sent the stock market tumbling the next day. Why did this happen?

For one, the hike in CRR is expected to suck out Rs 14,000 crore of liquidity from the system. Result: The funds available for lending by banks become scarcer, leading to higher interest rates on lending and on deposits. Following the CRR hike, a number of banks have announced increases in their key lending rates.

Impact of interest rates

Second, rising interest rates also have implications for the equity investor. If you an avid stock market investor, it is time to watch keenly the companies that you hold and the impact of interest rates on the sectors. For instance, companies in the auto and real-estate business may be vulnerable, as demand from their end-customers will be impacted by higher cost of financing or mortgaging. Similarly, some companies that have high working-capital requirements or are highly geared may see higher interest costs that could dent their bottomline. With ambitious capacity expansion plans lined by India Inc., this factor assumes more significance.

Identifying sectors that are less sensitive to interest rates and, more important, well-managed companies with a financial plan in place, may be the answer for the long-term. If this sounds too difficult, then you could be better off investing your money in mutual funds with a good track record and leaving fund managers to do the work.

In the short-term, the stock trading community has more to worry than the long-term investors. Leveraged positions typically used by traders could now cost more, driven by higher interest rates. This means that stock market positions will now have to generate higher returns to make up for the higher borrowing costs. Traders may, therefore, have to be discreet while taking huge leveraged positions, as the losses can really hurt.

Floating options

If the whole issue of how companies and their stocks will react worries you, the debt market has something to cheer you up. Mutual fund options that invest in floating rate instruments will benefit from rising rates and may be attractive vehicles to park your money. So will fixed maturity plans being launched from now on. Investors could stick to those with a short maturity. If you can take a bit of risk, even the debt-oriented monthly income plans (MIP) may be worth considering. Similarly, with the current uptrend in bank deposit rates, fixed deposits may once again turn out to be good avenues even on a post-tax basis. Any tax-sops on the interest income from FDs in the upcoming budget would be an added bonus.

Even with an increase in interest rates, the time may not be ripe to lock your money in long-term debt instruments as the rising bias in interest rates may continue for a while. Locking into long-term instruments may prevent you from revisiting interest rates on your investments at a later date.

Borrowing woes

On the borrowings side, if you have taken a floating rate loan, there is little you can do than bear the brunt. Sad, but you will probably have to expect either the tenure of your loan or the EMI to spiral upwards if you have an existing home loan on floating rate. For a fresh home loan, you may have to settle for a lower loan amount or a longer tenure, based on affordability.

No easy way for consumer loans or vehicle loans either, as the cost of money is higher, whatever be your purpose for borrowing. The best that can be done is to act wisely, be it borrowing or investing.