RBI has hiked its policy rate by 0.25%. This will likely translate into higher loan rates and may be a little higher deposit rates too. But the more important item has gone amiss in this announcement. And it is important to you.
INFLATION.
The big reason RBI went ahead with its ‘first in four years’ raise in rates is the demon of inflation rearing its head. You know about the high oil prices, likely government (both state and central) doles in an election year, upcoming raise in government employee Salaries/HRA, etc.
All of these are likely to push the inflation number up. RBI has been trying to keep inflation under control as a part of its policy measures and is not comfortable with the scenario. Hence, the increase in the rate. You should note that this is just first of the many increases that may happen.
Quite interestingly, the markets had already factored this rate hike. In fact, more. As other experts also opine, about 0.50% of hike has already been discounted in prices. So, as per market forces, at least one more rate hike is definitely coming.
Of course, if you are a borrower, you will find the interest rate going up. Many banks have already increased their lending rates by 0.10 to 0.15%. If you are a depositor, banks like SBI, ICICI and PNB too have increased their deposit rates. These rates (lending as well as deposits) may go up further.
However, that’s not the key point I want to make today. I want you to take your attention back to the key word – INFLATION.
As a high growth economy, India is likely to witness higher inflation than other countries. We hear inflation rates of 1% or 2% for developed countries such as US and Singapore. In India, the numbers are typically 4% to 6%. Well, that’s the statistic of Consumer Price Inflation.
The reality of our lives is that our personal inflation is more. Hence, when you are preparing for your financial future, please remember that a 4, 5 or 6% inflation is not relevant to you. Your actual inflation is closer to 8% or 10% or more if you have a different standard of living.
Unfortunately, I have seen several investors using and some online planning calculators suggesting a 5% or 6% inflation rate. This is ridiculous. By using a 5% inflation, you can lower the savings number and feel that your goals are more reachable, but this is calling for trouble in the future.
You are essentially under preparing yourself for your money requirements, be it your children’s education or your own retirement.
Use the following calculators to use different inflation assumptions and see the difference.
I expect that India will remain a high growth economy at least for the next 2 decades. In that scenario, our inflation is likely to be higher too before it goes to settle down to developed economy numbers. Till that time, you are better of using a higher inflation number for your plans.
Let me suggest a minimum of 8%. Take a higher inflation rate, if you will. It is better to be over prepared.
And yes, as per RBI, the near term inflation increase is already in sight. No reason, it will be very different a few years from now.
What’s your personal inflation rate?
How do you suggest factoring in interest rate when thinking about balancing debt/equity? For example, if the FD rates go above 12%, long term debt starts getting really attractive compared to equity.
That’a a more tactical call and can be taken based on the prevailing scenario. So, yes, tactically, you may want to increase exposure to debt at that time. But a lot remains to evaluate when doing so.
Hi Vipin
Thanks for pointing out the difference between consumer price inflation and personal inflation. My question is, how to calculate personal inflation? It would be great if you throw some light on it.
Thanks
Hi Kshitij, start with making a list of things that you consume or are likely to consume in a couple of years and make a quick comparison of prices (you may ask people who are buying stuff in your family). If you observe it for a few years, you can get a good handle. If you are prone to spending on more than necessities, you can rest assured that you are buying more stories about the stuff than the stuff itself and hence your personal inflation will be much higher than the stated regular inflation. 10% or 12% may be. IN other cases, as you upgrade your life style over the years, the things you consume change too. Rs. 20 coffee to rs. 200 coffee. Rs. 100 for a haircut to Rs. 500 for a haircut and so on and so forth. All the best!