Are you also feeling the inflation pinch? It’s no secret that inflation impacts everything from the price of groceries to cars. But did you know inflation also impacts your FDs and other investments?
Inflation’s Impact on Markets
- Inflation results from the pace of economic activity
- A growing economy leads to inflation, and a slowing economy will lead to deflation (falling prices)
- A reasonable inflation rate is a good sign for a growing economy
- 2-6% is the range of good annual inflation for an economy with the growth potential of India
- Inflation reduces your capacity to spend money/buy stuff
- High inflation hurts the lower-income groups more as a majority of their spending is on essential goods like food
- High inflation can result from a fast pace of economic growth or rising demand for goods, or usually both
- RBI may intervene to control inflation and protect lower-income groups from its side-effects
- RBI will try to increase the lending rates across the board for banks, with an intent to reduce the money supply in the economy
- Less money and high borrowing cost causes businesses to slow down their investment projects and thus puts a brake on the economic growth
- However, deposits at banks will increase as FD rates increase
- Banks and financial institutions also experience a slowdown in business due to high borrowing rates
- Thus, overall stock markets will register this as a stagnating growth or outright fall in the indexes
What is CPI or Consumer Inflation?
Let’s explore and shed new light on your understanding of inflation.
The general understanding of inflation is the rise in the price of everything we consume. For example, you could buy a bicycle for Rs 3000 in 1997, but in 2017 the prices were Rs 10,000. That is an annual inflation rate of 6.2% for the cycle.
CPI, or the consumer price index, measures the inflation that affects individual consumption. The index records average price rise across various commodities and services for individuals.
Last year (2022-23), CPI registered a growth of 6.44%. That means the prices of everything in India rose by an average of 6.44%. This is significant because this figure is higher than the RBI’s tolerance limit for Indian inflation.
Another way of looking at this rise is that the value of money reduced by 6.44% in the last financial year. Thus, if you had Rs 10,000 on 1st April 2022, it was worth only Rs 9,395 by 31st March 2023.
Inflation vs Lifestyle & Investments
If you are to maintain your lifestyle despite inflation, your income must also grow. In this example, if your income grew by 10% while the inflation was 6.44%, your real purchasing power should be about Rs 10,334 after a year.
You can also use this method to judge your investments.
This is why income growth is important for everyone. If your income grows more than the inflation, you may not feel the pinch as much. Also, inflation for different commodities can be different. Thus, based on their lifestyle and income growth, inflation will affect various segments of society differently.
For example, food inflation affects lower-income groups the most.
High inflation also signifies the importance of investing your money regularly. Investing protects your money from the effects of inflation and secures your future. The compounding of long-term investment makes your money make more money for you even while you are asleep.
So, regardless of markets going up or down, invest a little every month. You can include commodities like Gold, apart from stocks and bonds, to better keep up with the inflation.
Inflation vs RBI
From RBI’s point of view, mild inflation between 2-6% is a sign of a healthy economy. 6% might sound a bit high, but India is one of those economies with huge growth potential.
Mild inflation means that incomes and production both are rising simultaneously. Thus, the demand will also maintain healthy growth. High inflation often means inadequate productivity or unequal income growth.
Whenever inflation crosses the upper threshold, RBI may raise the Repo rate. Repo rate increase directly impacts the lending rates for banks. With the high cost of loans enterprises and other borrowers must either stop borrowing or borrow lower amounts.
Thus, the money supply reduces in the economy, and the following two things happen:
- Economic activity slows down as businesses postpone or reduce their investment
- People have less money to spend. Thus, the demand for goods also reduces
Increasing repo rates can hurt the banks’ growth while stemming the flow of funds to businesses. At the same time, banks can offer higher interest to investors on deposits.
The repo rate increases end up slowing the economic activity across sectors except for agriculture. Thus, high inflation can result in declining or stagnating stock markets. But at the same time, new fixed deposit rates will rise.
Is your investment portfolio preparing your finances for the future?
Leave a comment if your investment portfolio has done better or worse than inflation for the last five years. Inflation averaged about 5.5% p.a. in this period.