Inflation when out of control is a serious problem and the Indian Subcontinent is no stranger to the wrath of inflation. Think of inflation as a ‘silent tax’ – a guaranteed amount of money you lose with no exception. The inflation rate in India is around 6% which means that your money under the mattress depreciates by 6% every year.
Inflation: Meaning and Types
The book-ish definition of Inflation is “the general rise in prices of goods and services that naturally implies a fall in purchasing power of the consumer”. However, to help you understand the seriousness of inflation, I’d like to propose a different definition… “Rate of Inflation signifies the guaranteed amount by which you will be poorer next year.”
Around the 1960s, you could pay for groceries with Re.1 – today all you can buy is an eraser.
That is an example of your money depreciating in value.
There are a couple of reasons this occurs but rest assured, Inflation is a mystery. Do not let Economists tell you anything else except the fact that little is known about Inflation.
There are two main types of inflation – Demand-Pull Inflation and Cost-Push Inflation. There are other types of inflation such as Built-In inflation. The line really does get hazy.
This is too much money chasing too few hands. When the overall demand(aggregate demand) exceeds the overall supply(aggregate supply) – there is a general rise in prices which is termed as ‘demand-pull inflation’.
When the increase in prices is caused due to supply channel issues, it is called cost-push inflation. This occurs when there is a rise in price of labour or raw material for production which leads to a rising prices. These rising prices cause a fall in the aggregate supply and a new equilibrium is reached.
Inflation Rate in India
India is a developing country and therefore, the rate of inflation is different from other developed nations such as the USA or EU. Developing countries are nations that still have widespread poverty, unequal distribution of wealth, underdeveloped infrastructure etc, and are on the runway to fix the basic problems in their society.
Since the developing countries have a large runway ahead of them, they can grow at higher rates and have higher rates of inflation.
In India, the average rate of Inflation has been around 4-6%. It was much higher during the UPA government and then Dr. Raghuram Rajan was called – he controlled the beast and brought the inflation rate down to 5.5%. Currently, the Inflation rate in India is at 5%.(many believe this isn’t the actual number)
Measures of Inflation
Inflation is calculated by taking the price of a basket of goods and services (which comprise the index), multiplying them with the weight assigned to them, and then taking their average.
There are, overall, 4 different measures of inflation – Consumer Price Index, Wholesale Price Index, Core-Inflation Index(CPI – (Food + Crude)), and GDP deflator.
There are various demerits and merits of using each.
Threshold Level of Inflation
Like it is the case with most things, Inflation is both good and bad. Controlled Inflation is considered to be beneficial (even necessary) for economic growth and activity. Inflation means a demand for goods and services which also means expectation-formation, which is extremely important for the economy. These expectations by the workers act as both incentives and capital for the economy – workers form expectations and work and save accordingly. Additionally, inflation promotes competition which ensures a benefit for the customer.
‘Threshold Level of Inflation’ means the optimal level of inflation. It is the level of inflation above which GDP growth starts to fall. The RBI tries to stay around this level by a mechanism called ‘Inflation Targeting’.
In India, the Threshold Level of Inflation is argued to be between 4% and 7%. The RBI has a ‘band’ of 4%∓ 2%. If the CPI exceeds the level of 6%, the RBI responds with a contractionary monetary policy.
This is a rule-based policy. A rule has been set where if the inflation exceeds a certain percentage(6%) – a contractionary monetary policy will be used.
Predicted Inflation Rate in India in 2022
We don’t believe in the idea of pretending to know more than we do. We do not know what the inflation rate is going to be next year, even Nirmala Sitaraman doesn’t know. Economists can make an estimate of the next quarter but after that, all predictions go haywire.
The red line presents the actual level of unemployment while the green line presents the expected level by economists. In every case, without exception, only the forecast of the first quarter was close to the actual results.
Why is there likely to be high inflation?
The central banks around the world have printed trillions of dollars in recent months with very low-interest rates. This typically indicates that inflation is to follow. The argument against this idea was that people will realise living and spend more after the pandemic and then, the economic activity shall take care of the earlier printing but unfortunately, that didn’t happen. People after the pandemic realised the importance of life and started a ‘Great Resignation’ i.e. they quit their high paying jobs and enjoying a minimalist lifestyle time with their families. There are even certain pointers of inflation creeping into our economy( by companies raising prices because their raw material prices are rising”.
“We are raising prices. People are raising prices to us, and it’s being accepted.”– Warren Buffett(at Berkshire AGM in May, 2021)
This acceptance shall not always continue and we might see a higher inflation period around the globe after some time. By these standards, we can expect the inflation rate in India to be much higher than 7%. There is also evidence of higher WPI. Recently, India recorded the WPI at 14% (a 12-year high). And this surge shall find its way through into CPI after a lag as per IMF Chief Economist, Gita Gopinath.
How to Beat Inflation
If you put your mind to it, you certainly aren’t beating Inflation with money in your bank account. Frankly speaking, the only reason to put money in a bank account is that it’s safer than keeping it under your mattress – believe me, considering inflation, they’re not that far apart. Additionally, even if you have FDs present, you’re hardly beating inflation either.
So then comes the question of how you can preserve your purchasing power. The answer to that is by diversifying across asset classes like Gold, Equity, Real-Estate, etc.
If you want a return of around 9%CAGR, which is inflation-beating, you can put some of your corpus in Gold. For ambitious returns, you can invest some other portion of your money in Equities as well and enjoy about 13% compounding. If you wish to understand more of this, we recommend reading this article on How Much Should a Beginner Put in The Stock Market.
If you’re younger and more inclined to invest in equities, mutual funds, understand the difference between Active and Passive investing, trading and maybe even wish to understand Crypto – you can find it on our website as well.