People save for the future. The very least they expect is that their investments will not be eaten away by inflation. Indians have few ways to protect themselves from its ravages.
This newspaper reported in its Monday edition that just about every financial instrument that the great Indian middle class depends on for future security now earns less than the inflation rate. The value of household savings held in banks, provident funds and securities such as National Savings Certificates are shrinking in real value. Some economists—quite rightly so—say that this will be a less of a problem once inflation peaks a few months down the line. But even if we assume that inflation eventually settles down in the high single-digit for the rest of this year, real returns will be negative.
In 1995, the last time inflation was at these levels, most of the savings options mentioned above earned around 12%. Real returns were negligible, but positive. The overall drop in interest rates in the early years of this decade did help push consumption and investment—and the current inflation as well. We would not be surprised if the labour unions demand higher returns on provident funds. Banks, too, have started raising deposit rates in response to cues from the Reserve Bank of India (RBI).
Illustration by: Jayachandran / Mint
There is a larger problem here. Indian savers have very few investment options to hedge themselves against high inflation. The traditional answer is buying gold. Those who have been bitten by the gold bug have earned handsome returns over the past year, beating inflation by a wide margin. Gold is also a useful hedge against a depreciating rupee.
But India needs a wider variety of financial instruments in these inflationary times. One: mutual funds that primarily try to protect investor capital rather than attempt to track or beat a market index. Two: inflation-indexed bonds that guarantee a certain yield above the inflation rate. RBI had experimented with such a bond earlier in this decade, but it was discontinued. The US Fed has been selling Treasury Inflation Protected Securities (TIPs) since 1997.
Interest rates are market- determined—and they will jump above and below the inflation rate, depending on the state of the economy. But the regulators have to seriously ask themselves why Indians do not have a wider range of investment options. It’s time the debate was flagged off.
Do Indians need more hedges against inflation? Write to us at firstname.lastname@example.org