How best to tackle Inflation - Part II

Prices on fire

Why inflation rose to a record high...

• Rising oil prices. At an all-time high of $140 per barrel, oil prices have more than doubled from $64 a barrel in April 2007, fuelling inflation.
• Rising food prices. A global shortage of food grains, such as wheat and rice, has made the food prices index shoot up by about 10 per cent, pushing up inflation.
• High commodity prices. High prices of commodities such as steel and cement due to their less-than-adequate supply has made industrial production, housing, roads, airports and other crucial infrastructure more expensive.
• High cost of funds. To combat inflation, the central bank is sucking out excess money from the economy by increasing cash-reserve ratio and increasing repo rates so that less money chases the limited supply of goods and services. This, however, is also driving up the cost of existing funds, that is interest rates, adding to inflation.
• Rupee's eroding purchasing power. Rising prices are eroding the value of what the rupee can buy vis-a-vis other currencies such as the dollar. The rupee's fall of around 8 per cent in the last six months has made major imports like petroleum and edible oil costlier, fuelling inflation.

...and why it will continue to remain high

• New era of high oil prices. With little prospect of increase in international oil supplies, production declines in some oil producing countries, increasing oil production costs, taxes on oil exports by producing countries and speculative investments in oil by large international investors, besides continuing high oil demand, oil prices are expected to remain high.
• No respite from high food prices. While the situation of shortfall in supply is likely to improve in the next 6-8 months, higher input costs in the form of costlier diesel, seeds, fertilisers and the like will neutralise the impact of enhanced food supply.
• Uninterrupted rise of commodity prices. As most stock markets across the world test lower levels, investments by institutional investors pouring into commodities is expected to keep commodity prices high. Also, with no sign of demand for commodities from high-growth countries like China tapering off, no relief seems to be in sight.
• High interest rates to continue. As long as high prices remain, with limited fiscal policy options, the Reserve Bank of India will either make attempts to suck out money or ensure status quo. This will mean continuing high interest rates and inflation.
• continued pressure on the rupee. Various domestic and international macroeconomic factors are expected to keep up the pressure on the rupee, which will make imports more expensive.

How high inflation will affect you

• Higher Budgets. Get ready to pay more for vegetables, groceries, especially soaps, detergents, packaged food, personal and public transport, as well as for services such as couriers.
• Costlier loans. You can expect costlier loans, especially car and personal loans. New home loan rates are likely to go up even as the tenure or EMIs of existing home loan rates go up.
• More expensive recreation. Higher airfares along with lower purchasing power will make international travel more expensive even as domestic leisure becomes costlier.
• Dent on returns. Fixed income options such as bank fixed deposits and monthly income options will give negative returns after adjusting for inflation, impacting senior citizens, single parents and risk-averse investors such as those with many dependents. Impact on corporate profitability via higher costs will bring down stock prices.
• Higher taxes. To raise more money to cushion vulnerable parts of the population the government might impose higher taxes, cesses and surcharges on goods and services.
• Lower infrastructure growth. Upcoming road, airport, power and port projects will witness cost escalations and might see slow downs.
• Some layoffs and lower pay hikes. Hard hit sectors such as aviation could see some layoffs while most sectors are likely to witness lower pay hikes. This may be especially true in the IT and the BPO sectors.
• More austere workplace. Expect fewer office parties and conferences, reduction in amenities, office travel and allowances as employers try to cut corners to save costs.