Inflation erodes your investments. The real rate of returns is affected because of inflation. Inflation is an economy-wide sustained trend of increasing prices from one year to the next. The rate of inflation is important as it represents the rate at which the real value of an investment is eroded and the loss in spending power over time. Inflation also tells an investor exactly how much of returns his investments need to make for him to maintain his standard of living.
Recently, the Reserve Bank of India (RBI) said inflation may 'spiral out of control', hurting investments and economic growth. This is an indication that policy rates will keep rising till they creates an atmosphere for sustained growth. According to the RBI, the current rate of inflation does raise concerns of spiralling. A high inflation rate can get increasingly entrenched into the wage and price-setting behaviour of workers and producers. In turn, if this were to adversely impact investment activity, the growth momentum will inevitably slow down. In essence, the trade-off is more between inflation now, and growth in the future. The RBI has indicated that price rise is now widespread. According to the RBI, the supply side is spilling over to manufacturing, and that could keep inflation at elevated levels.
The inflation rate that started climbing up due to rising food prices two years ago, and is fast spreading to all parts of the economy. That is forcing wage-earners to seek higher salaries and is triggering product price increases. Wholesale prices rose 8.31 percent in February, above the RBI's eight percent target that was revised many times. Food inflation was at 9.5 percent for the week ended March 19. Crude oil price is near USD 120 a barrel. Gold, copper and silver prices are at historic highs.
The RBI raised rates eight times in 13 months to 6.75 percent, but the negative real returns continue. It signifies the magnitude of the spill-over of higher food and oil prices to generalised inflation.
Global inflation is threatening to plunge economies into crisis. China raised interest rates for the fourth time since the crisis ended. The US Fed and European Central Bank are also voicing their concerns about the destabilising effects of price rise.
According to the RBI, inflation and expectations have to be monitored extremely closely and price stability has to be maintained. Over the past few months, the RBI has taken a series of monetary steps such as one-day repos, liquidity adjustment facility and vigorous interventions through market stabilisation schemes to keep the situation under check. It has also hiked the cash reserve ratio (CRR), repo rate and reverse repo rate.
Inflation represents one of the major threats to equity investors. When the inflation rate starts to rise, investors get worried about the possible negative consequences. The rising prices and the higher interest rates don't lead to positive effects on the investment portfolios of investors.
Inflation has another negative impact - the prices rise but no additional value is added. This means your rupee loses purchasing power and as a result you buy less with the money you have than before. Inflation erodes purchasing power and senior citizens on fixed incomes suffer when their income buys less each passing year. The more cash or cash equivalents you hold, the worse inflation will affect you. Rs 1,000 in cash today may turn out to be worth only Rs 900 in a few months.
