CPI Inflation quickened from 3.99% in September 2019 to 4.62% in October led by a surge in food inflation. The Consumer Food Price Index rose by a higher 7.89%. Onion prices have risen by about 90% over the past year to reach 35 per kg at all India level and as much as 80 per kg in metro cities such as Delhi and Mumbai. The spike in inflation is a departure from the muted trend over the past 3-4 years. CPI Inflation averaged 3.4% in FY 2018-19, 3.6% in FY 17-18 and 4.5% in FY 2016-17.

Investors should not make any drastic changes to their portfolio based on what may be transient changes in inflation. However higher inflation adds to other pressures that can send interest rates higher such as slowing growth and weak tax collections. The latter two factors can result in a major breach in the Government’s fiscal deficit target and hence a rise in interest rates. Investors should thus avoid locking into long term fixed rate products at today’s historically low rates. The RBI repo rate at 5.15%, to which lending rates and ultimately deposit rates are linked, sits at a 9 year low.

Similarly those who have invested in long duration debt mutual funds or gilt funds should consider reducing their allocation to such funds. Higher interest rates reduce the returns delivered by these funds. However investors should evaluate the tax implications and exit loads attracted by any such changes. Debt mutual funds sold within a 3 year holding period are taxed at slab rate. Thereafter they are taxed at 20% with the benefit of indexation. Those who have invested in equity funds for the long term have less cause to worry. Over the long run, corporate earnings adjust to higher prices and stock prices rise. However unstable inflation can cause short term volatility in stock prices as well

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