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 either the Central or State governments or public sector units are unlikely to be receiving 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, respectively, SBI offers 5% and 5.50%, for the same tenors, 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 have to be dependent on their children.
In recent times, the efforts of the Reserve Bank of India to fight the economic slowdown has meant a further fall in interest rates. But, after a brief period in the middle of the last decade, deposits have ended up delivering negative real returns. Wholesale price inflation is raging at 10.5% and consumer price inflation has averaged above 5% for a year and is inching up. 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 to them.
Moreover, rising consumer prices will lead to a rise in wages demanded, leading to greater input costs, which will once again push up prices. This is an inflationary cycle that decimates growth leading to stagflation.
To tackle stagflation, the RBI would have to implement a contractionary monetary policy, which means interest rates would have to rise, and would 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 the equilibrium level. Instead, they are willing to be out of business than to 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 both 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. But with excess liquidity washing up on our shores from foreign central banks adopting easy money policies and given the market euphoria, equities are highly overvalued. Real estate is not particularly viable either 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 a further loss of 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 deduction of tax. 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.
(Anand Srinivasan is a financial consultant, reachable at anand.s.srinivasan@gmail.com)
