The amount you pay to buy 250 grams of vegetables was buying you one full kilogram of veggies just few years ago. That is the rate at which cost of living is going up for the common man. Still, India's Wholesale Price Index (WPI) suggests that inflation has come down significantly in calendar year 2013, despite some upward movement witnessed in past few months.

Implications...
Being wary of the potential threat of diminishing purchasing power, Indian investors have been chasing gold to hedge themselves against such high rate inflation. This resulted in India importing huge quantity of gold. Higher gold imports affected India's current account position extremely negatively. As a result of which Indian currency lost its value sharply over last few months. To correct this, Indian government and RBI took a number of steps to discourage demand for gold. This included hiking duty on gold imports and barring banks from selling gold among others. There were few more suggestions to divert people from buying gold and real estate for the purpose of safeguarding themselves from ill-effects of high inflation. Need for launching inflation-linked bonds was being repeatedly discussed. Finally, in June this year, RBI launched Inflation Indexed Bonds (IIBs) tracking the movement of Wholesale Price Inflation. However, IIBs tracking movement of WPI don't offer adequate hedge against inflation. Let's understand why.

Wholesale Price Index (WPI) primarily captures the movement of industrial inflation which has about a two third of weight in the index and only about 20% the index represents price inflation in primary articles. On the other hand, about 50% of the weight has been assigned to food price inflation in Consumer Price Index (CPI). Thus, CPI is a better indicator of retail inflation than WPI. A common Indian spends sizable portion of his earnings on buying primary articles such as food. This is why investors would be less enthused to buy products protecting them against wholesale price inflation.
 

CPI vs. WPI Inflation

(Source: Central Statistical Office, RBI, PersonalFN Research)  

To divert investors from gold; it needs to be ensured that investors are adequately protected from consumer price inflation. Acknowledging this need, the new RBI governor had assured about considering launch of IIBs tracking CPI.

How would they work?
CPI-linked instruments launched in the form of savings certificates, would have two variations. One would pay lump-sum at the end of tenure whereas; the other will pay index-adjusted interest every year. The bonds might be floated before the end of November 2013.

PersonalFN is of the view that, the proposed CPI linked investment products might help India curb gold demand and in turn gold imports. However, besides investment demand, India has a huge consumption demand for gold. CPI linked investment products may not help it control such demand.

Nonetheless, PersonalFN believes, CPI linked products would offer a better hedge to investors worried about rising cost of living. Which product one should invest in, is a tough decision to make right now since no further details are available about the proposed products. PersonalFN recommends investors to consider investing in CPI linked investment instruments as and when they are launched after carefully assessing options.

Add Comments