Bonds vs. Stocks
Navigating Inflation: Financial Strategies for Indian Citizens Amidst Economic Challenges.
(Anand Srinivasan and Sashwath Swaminathan authored this article in The Hindu Newspaper on June 13, 2021. Much of the content remains relevant today.)
These are difficult days for the Indian middle and lower middle class, especially senior citizens who do not have a regular pension. Most who have not worked for the Central or State governments or public sector units are unlikely to receive pension benefits indexed to their last-drawn salaries and inflation. Instead, these senior citizens depend on income derived as interest from fixed deposits in scheduled banks.
While HDFC Bank offers 4.9% for regular depositors and 5.4% for senior citizens on fixed deposits of maturities of 1 year to 2 years (this number stands at 6-7.75% as of 2024), respectively, SBI offers 5% and 5.50% (this stands at 6.8-7.3% as of 2024), for the same tenures, for the respective categories.
Ravages of Inflation
Over the years, the ravages of inflation have meant that these citizens, who held senior positions in the corporate world, face genteel poverty or often depend on their children.
In recent times, the efforts of the Reserve Bank of India to fight the economic slowdown have meant a further fall in interest rates. But, after a brief period in the middle of the last decade, deposits have delivered negative real returns. Wholesale price inflation is raging at 10.5% (much lower in 2024), and consumer price inflation has averaged above 5% for a year and is inching up (continues to remain around this rate in 2024). The inflation in consumer prices is unlikely to slow any time soon, as the demand for commodities is bound to go up. The producers will pass on the commodity price inflation to the consumer in the prices of goods sold.
Moreover, rising consumer prices will increase the wages demanded, increase input costs, and push prices again. This is an inflationary cycle that decimates growth, leading to stagflation.
To tackle stagflation, the RBI would have to implement a contractionary monetary policy, meaning interest rates would have to rise and harm an already fragile economy.
Another factor to consider is the ratchet effect, popularised as an economics concept by John Maynard Keynes. The ratchet effect states that after a period of consumer price or wage inflation, the producers and labour markets fail to correct their prices to equilibrium. Instead, they want to be out of business rather than lower prices. The ratchet effect means that fighting inflation becomes an even bigger problem.
Shrinking options
Returning to the predicament of the common citizens, the real value of their capital and interest earned on savings is declining rapidly today. The lower-income and middle classes need a way to guard their wealth and income against inflation. The stock market is usually seen as the saviour of wealth against inflation. However, with excess liquidity washing up on our shores from foreign central banks adopting easy money policies, equities are highly overvalued, given the market euphoria. Real estate is not viable due to high prices and low rental income yields. Gold is a possible way to guard against inflation, but gold does not provide regular income as it is an unproductive asset. Additionally, it is not feasible to park large amounts in an asset such as gold due to the costs involved (storage and safety costs).
Therefore, senior citizens and the general investor are left with one asset class: bonds. Senior citizens should shift to high-quality corporate bonds issued by reputed companies and banks to protect themselves from further losing principal and interest. These bonds are traded daily and can be liquidated at short notice in an emergency. Since these instruments are tradeable, there is no tax deduction. This leads to superior tax planning in the hands of the investor. The yields for highly-rated companies are in the region of 8.5-9%. These are attractive returns for high-quality bonds. Senior citizens and regular investors could buy these instruments to mitigate the risk of negative real returns due to rampant inflation.
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