It's time to visit your portfolio and weed out investments whose inflation-adjusted returns is low or negative
On June 4, the central government announced a price hike of Rs 6 per litre of petrol, Rs 3 on diesel and Rs 50 per LPG cylinder, together with customs and excise duty cuts in an attempt to save the oil marketing companies from bankruptcy. Oil marketing companies buy crude oil from the international markets and distribute it in India. India imports 73 percent of its petroleum needs as the production of crude oil here is very little.
The price of crude oil in the international markets has nearly doubled from a low of $60 per barrel in May 2007 to $130 a barrel in May 2008. The retail price of crude in India, administered by the government, has not been raised since 2004. Hence, these oil marketing companies have been running a very unprofitable business of buying crude at high prices and selling it to domestic consumers at low prices. In this process, they have accumulated mind-boggling losses of Rs 2,000 billion and were facing a severe liquidity crunch.
These firms were losing Rs 21.43 on the sale of every litre of petrol, Rs 31.58 per litre on diesel Rs 35.98 per litre on kerosene while losses on LPG were Rs 353 per 14.2-kg cylinder. Oil marketing companies therefore lost money every time they made a sale due to their inability to peg their selling prices to the purchase price of crude. To defuse this crisis, the government raised fuel prices by an average of 13 percent with full knowledge of its impact on inflation.
Impact on inflation
The current annual wholesale inflation is already high at 8.1 percent. The government expects the effect of price hike on inflation to be marginal at around 60 basis points. Others, however, are not so positive about the impact of the price hike. Crisil, the rating agency, felt that it would push up inflation by 95 basis points taking into account both direct and indirect impacts. Out of this, the direct impact will be 51 basis points with the highest contribution coming from the hike in the LPG price. The indirect impact, which will be felt over the course of the next few months, will be 44 basis points.
Economists are of the opinion that inflation will flare up to a 15-year high of 14 percent due to the price increase. A rate of nine percent would be the highest inflation since 1995.
A high inflation rate affects the consumer at the retail level and the corporate profits too. The cost of living rises and the consumer has to pay more for the same goods and services. At the corporate level, the higher cost directly impacts the bottom line. Their inability to pass on the price increases to the consumer further squeezes their margins. This in turn directly affects the stock markets, which prices future earnings of all companies listed with it. The fuel price hike caused the Sensex to lose nearly 400 points on Wednesday, June 4. Investors' reaction reflected the anxiety about the likely impact of the fuel price hike, which was more than what the market expected.
Now, all eyes will be on the Reserve Bank of India (RBI) as inflation is now beyond its comfort zone. Whether the RBI will raise the cash reserve ratio (CRR) or even raise interest rates is now a matter of conjecture. But economists feel since price pressures are largely beyond its control, and the RBI will maintain a measured response to fight inflation by managing CRR in the banking system rather than raising interest rates, which could impact growth.
Impact on savings
Inflation not only increases the prices of all food grains and services but also impacts your retirement corpus. It increases the amount you have to save up. For example, if you feel Rs 10 lakhs is a good amount retire with at the age of 60 and inflation is at five percent, you will have to save up Rs.33.86 lakhs to afford the same cost of living 25 years hence. The farther away you are from retirement the more you have to save to maintain the same earning power. These calculations are at an inflation rate of five percent and a higher inflation only pushes the quantum further up.
Hence, it makes immense sense to revisit your portfolio and weed out those investments whose inflation adjusted returns are very low or even negative. Exploring investment avenues that would protect your capital from being eroded by inflation is a must in these uncertain times.
On June 4, the central government announced a price hike of Rs 6 per litre of petrol, Rs 3 on diesel and Rs 50 per LPG cylinder, together with customs and excise duty cuts in an attempt to save the oil marketing companies from bankruptcy. Oil marketing companies buy crude oil from the international markets and distribute it in India. India imports 73 percent of its petroleum needs as the production of crude oil here is very little.
The price of crude oil in the international markets has nearly doubled from a low of $60 per barrel in May 2007 to $130 a barrel in May 2008. The retail price of crude in India, administered by the government, has not been raised since 2004. Hence, these oil marketing companies have been running a very unprofitable business of buying crude at high prices and selling it to domestic consumers at low prices. In this process, they have accumulated mind-boggling losses of Rs 2,000 billion and were facing a severe liquidity crunch.
These firms were losing Rs 21.43 on the sale of every litre of petrol, Rs 31.58 per litre on diesel Rs 35.98 per litre on kerosene while losses on LPG were Rs 353 per 14.2-kg cylinder. Oil marketing companies therefore lost money every time they made a sale due to their inability to peg their selling prices to the purchase price of crude. To defuse this crisis, the government raised fuel prices by an average of 13 percent with full knowledge of its impact on inflation.
Impact on inflation
The current annual wholesale inflation is already high at 8.1 percent. The government expects the effect of price hike on inflation to be marginal at around 60 basis points. Others, however, are not so positive about the impact of the price hike. Crisil, the rating agency, felt that it would push up inflation by 95 basis points taking into account both direct and indirect impacts. Out of this, the direct impact will be 51 basis points with the highest contribution coming from the hike in the LPG price. The indirect impact, which will be felt over the course of the next few months, will be 44 basis points.
Economists are of the opinion that inflation will flare up to a 15-year high of 14 percent due to the price increase. A rate of nine percent would be the highest inflation since 1995.
A high inflation rate affects the consumer at the retail level and the corporate profits too. The cost of living rises and the consumer has to pay more for the same goods and services. At the corporate level, the higher cost directly impacts the bottom line. Their inability to pass on the price increases to the consumer further squeezes their margins. This in turn directly affects the stock markets, which prices future earnings of all companies listed with it. The fuel price hike caused the Sensex to lose nearly 400 points on Wednesday, June 4. Investors' reaction reflected the anxiety about the likely impact of the fuel price hike, which was more than what the market expected.
Now, all eyes will be on the Reserve Bank of India (RBI) as inflation is now beyond its comfort zone. Whether the RBI will raise the cash reserve ratio (CRR) or even raise interest rates is now a matter of conjecture. But economists feel since price pressures are largely beyond its control, and the RBI will maintain a measured response to fight inflation by managing CRR in the banking system rather than raising interest rates, which could impact growth.
Impact on savings
Inflation not only increases the prices of all food grains and services but also impacts your retirement corpus. It increases the amount you have to save up. For example, if you feel Rs 10 lakhs is a good amount retire with at the age of 60 and inflation is at five percent, you will have to save up Rs.33.86 lakhs to afford the same cost of living 25 years hence. The farther away you are from retirement the more you have to save to maintain the same earning power. These calculations are at an inflation rate of five percent and a higher inflation only pushes the quantum further up.
Hence, it makes immense sense to revisit your portfolio and weed out those investments whose inflation adjusted returns are very low or even negative. Exploring investment avenues that would protect your capital from being eroded by inflation is a must in these uncertain times.
