Inflation - ‘Deflation’ - Inflation

The current phase of low inflation is temporary. With governments across the world pumping trillions of dollars into their economy, we must all be prepared for yet another phase of inflation.

It was just ten months back that we were grappling with mind-boggling double-digit inflation. The price of oil came crashing and so did the rate of inflation. From 13 percent levels, today it is struggling to stay above zero. And the media is full of stories on ‘deflation’ and its after-effects!

Initially, they scared the living daylights out of the common man with their stories on deflation and depression that has hit global economies. Thankfully, those stories seem past us today.

What I am more concerned about is inflation! Yes that’s correct - inflation.

I am no great economist, but I can definitely tell you that with the trillions of dollars being pumped into various economies (in order to bail out these economies by increasing liquidity) fiscal deficits are expected in the region of 12 to 14 percent. My concern stems from the fact that once these monies start reaching the retail consumer, they are bound to fuel inflation. It will be a case of too much money chasing too few goods - the latter being the fallout of the slowdown / recession in global markets.

In the last 12 months, the supply of money through various stimulus packages has grown manifold. Interest rates have eased and are expected to ease further (at least here in India) so that the consumer and businesses start availing loans and increase consumption.

Prices have witnessed a steep drop in order to boost consumption. But the start has to come from the consumer, and his or her desire to start purchasing (all over again). This will fuel demand and will make the manufacturer increase his production level. So the wheel will start rolling once again.

This, in turn, will cause the prices to increase as (in the beginning) there will be more money chasing fewer goods. Hence, inflation will rise from the near-zero levels (0.26% for the week ended March 28, 2009).

Provided crude oil prices (as one of the crucial factors) remain at around $60 levels, my guess is that inflation will claw its way back to 4-5 percent levels by the end of this year. The new government at the Centre will have to manage the fiscal deficit in a very deft manner.

Inflation and its impact on our investments

Price rise or inflation is a ‘silent killer’ of our investments. The return you get must be higher than the inflation rate for your investments to serve their real purpose.

Inflation is a hot topic of discussion these days. Newspapers and TV channels are full of reports that talk about how inflation, or price rise, is affecting the lives of Indians. Every week, the inflation numbers are more eagerly awaited and discussed than the Friday’s film release.

So what is inflation? And how does in impact us in the long run?

We have all heard stories of their good old days from our parents and grandparents tell us about how you could get a litre of milk in twenty five naya paisa and eat a meal out for Rs 5; how movie tickets used to cost 50 paise and more recently how with one hundred rupees of petrol in your car you could drive to office and back for a week.

“Look how times have changed. Things are so costly now,” they tell us. In layman language, this is inflation. It is nothing new. And yes, it is reflected in the prices of all items we buy.

But let’s look at it from another angle – inflation suggests that the purchasing power of money has come down. In short, for example the Rs 100 that could get us to office and back has probably become Rs 1000 today. In order to get the same service or product we have to pay 10 times more now.

This is one truth that most of us don’t budget for while planning for our future.

Inflation is a ‘silent killer’ of the investments that we are making today. A client of mine had purchased an insurance plan wherein after paying Rs 12,000 p.a. for 10 years, he was ‘promised’ a return of Rs 1,50,000 after 10 years. Looks good on the face of it? But look at the return that you are getting after an investment of 10 years – 6-odd percent per annum, which is lower than the inflation rate. So in reality your money at that time will not even allow you to purchase what it can, today. A sheer loss and a waste of time and opportunity!

Let’s take two examples and look into the future:

Assumption – you are 30 years old today and inflation rate is 10% p.a.

- If your monthly household expenses are Rs 30,000 today: at age 45 you would need Rs 1,25,000 to meet these same expenses.

- Rs 10,00,000 today would be worth Rs 2,05,000 by the time you are 45.

Whenever we buy products like insurance or invest in mutual funds or PPF, etc. with the purpose of achieving a financial goal, we must always take into account the impact of inflation on our end-corpus. It is definitely not going to be worth what the numbers today indicate. It is imperative that the return on our investments beats inflation in the long-run. Only then will we be able to meet our future requirements.

So the next time your ‘advisor’ tells you that so-and-so policy will get you Rs 1 crore in 25 years, do ask him what that Rs 1 crore will be worth then.