6 Hard-nosed Facts You Need to Know When Inflation Gets Deflated

By Hemanth | September 15, 2015

How prices affect inflation!

First, the good news.

Inflation, or rise in prices, has a bloody nose from the pounding it’s been taking this year.

While the Consumer Price Index (CPI) based inflation has dipped to 3.66% in August, the Wholesale Price Index (WPI) based inflation has plummeted to -4.95%. In fact, the WPI-based inflation has been floating in negative territory for close to a year now, leading to “deflation”.

Now, here’s what it means for you and here’s what you need to know as an individual investor or borrower.

1. When inflation drops, it means things that you buy for daily convenience and consumption are available at lower prices. This means your “purchasing power” has increased. With the same income of Rs. 50,000 a month, you can now buy more things within the same budget.

2. With a decreasing trend evident in inflation levels, there is a high likelihood that the RBI might reduce the repo rate, or the rate at which it lends to banks. There is added pressure on the RBI from corporate India on this front.

3. If repo rate reduces, your home loans, car loans, and personal loans may become cheaper. So, borrowers can rejoice.

4. As an investor, however, your deposits may take a beating, as deposit rates tend to drop right after repo rate cuts. This is likelier than loan interest rates dropping.

5. All is not lost for investors, however. Lower inflation means its ability to eat away at your investment returns is lower.

For eg., an investment of Rs. 1 lakh at a deposit rate of 9% would fetch you Rs. 53,862/- after 5 years. However, at 7% inflation, your real returns (adjusted for inflation) on the same amount would be just Rs. 9,701/-. Inflation would have eaten away Rs. 44,160/-. On the other hand, with a lower inflation of say 3.5%, your real returns on the same amount of Rs. 1 lakh would be Rs. 29,548/-. In this case, inflation has eaten away only Rs. 24,314/- of your returns. So, lower inflation means more real returns.

6. With reduced repo rates, companies and businesses may make more investments by borrowing more, thereby increasing work opportunities.

Even if none of these happen, you can be sure that your aloo, mooli, pyaaz aur dal will definitely be ‘sastha’! It can’t get more hard-nosed than that.

 

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