That India is well placed to benefit from its favourable demographic dividend is well known to all. The young population, the increasing work force and the rising salaries are just some of the many factors in favour of the 'Indian consumption theme'. However, with slowing volumes in recent times, doubts of whether the theme remains intact have been raised. And the key reason behind these slowing volumes is rising prices a.k.a. inflation.
Inflation has been an issue troubling the Indian economy for quite a few years now. Especially retail inflation, the one that actually impacts peoples' wallets! Putting money in a bank and earning an interest rate lower than the pace at which costs are rising simply erodes one's purchasing power. Multiply this over a longer period and the impact gets worse. This simple fact is what RBI Governor Raghuram Rajan believes is denting growth levels in India. Which is why taming retail inflation is very high on Dr Rajan's agenda. He made this pretty clear recently, setting clear targets for the new benchmark - the consumer price index - over a longer period.
In recent interviews with business dailies (Mint and Business Line), Dr. Rajan went on to say that there is no in between when it comes to growth and inflation. In other words, there is no trade off between the two. Inflation is simply hurting growth is his view. And only when the former is brought down, will the latter expand. The declining buying power of consumers, as expenses of essential items such as food and vegetables are moving up in their high single digits to the lower teen rates, has been hurting consumer demand.
Despite many pressures to lower interest rates, the governor is of the view that the changes made through monetary policies will not make much of a difference in terms of final lending rates from banks to customers. Given that deposit rates are set in line with inflation, it is the latter that needs to be reduced for banks to lower interest rates. His message to one section of people - India Inc. to be specific - demanding rate cuts is 'To put your house in order'. He opines that even if the central bank cuts rates, the likelihood of banks passing on the benefits to customers are very low given the high prevailing inflation rates.
With all this mess about inflation going around what is it that long term equity investors can do? Well investing in gold is one option, we believe. But the price of the same is dependent on many other factors as well and not simply inflation. Second option would be stocks. And within this asset class, the strategy would be to stay away from companies that have huge amounts of debt on their books. Rising interest rates would impact their interest and debt service coverage ratios.
We believe a good way to overcome the inflation monster would be to aim for companies that have an inbuilt inflation beating mechanism -pricing power. Combine that with return ratios well above the cost of funds and in all probability you have a winner. We believe having businesses with such characteristics does curb all inflation related risks. Buy them at good prices and you should very easily be able to earn returns to keep your purchasing power intact, or even improve the same.
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