How inflation is likely to impact your wallet?

Inflation is a general increase in the prices of goods and services in an economy. For example, imagine the milk you purchased 12 months ago for ₹50 is now selling for ₹60 per litre; or the employee a company hired for X salary is suddenly looking at a 2X salary — that is inflation.

India’s core inflation measure, at 7.7%, has already breached the upper bound of the RBI’s 2%-6% target range. The basic understanding is that when demand is more than supply, prices rise. But then there are unusual situations — like central banks printing money during crises or commodity prices seeing sharp swings when there are geopolitical concerns — that cause a spurt in inflation. Why is inflation rising now? Several factors have escalated inflation, and they are linked to the Covid-crisis or the Russia-Ukraine war.

1.     Supply Shocks

The economy came to a halt during Covid-19 and has still not recovered fully in many areas. When the supply of goods and services is disrupted by events like the pandemic or, more recently, by the disruption of supplies from giant commodity-producing nations like Russia and China, prices rise to meet such shocks.

2.     Central Banks: Printing Money, Lowering Rates

Central banks printed money and lowered interest rates to boost struggling economies during the Covid-19 crisis. Banks printed record amounts of money to help people during Covid-19, and this led to the amount of money chasing a small number of goods increasing, and prices consequently rising. While the dynamics are not that simple, the money printing by central banks has been a cause of inflation.

3.     Commodity Crisis 

The Russia-Ukraine war has impacted the supply of commodities and will affect commodity markets and trade. These commodities have led to a sharp increase in prices. Many industries, including FMCG, Cement, Agro-commodities and Automobiles, have struggled with the commodity price rise. The effect of rising rates What has not fallen due to the rising rates? Of course, the US Dollar hasn’t, nor have US bonds. The large-cap index has corrected, while small caps have seen a deeper correction. Most sectors have felt the heat. Metals have had the worst effect due to commodity prices cooling off; real estate and infrastructure have melted due to the rate hike, and IT is falling as an after-effect of the US stock crash. Only FMCG, Autos, and Energy have held up. What happens next? Higher interest rates will ripple through the economy. Home loans, car loans and business loans will become expensive, slowing down cash flows. This can lead businesses to amend or pause their growth plans. But all is not lost. In six out of nine such rate-hike cycles, the stock market has given a 16% average return, and we can expect an appreciation when the volatility and uncertainty abate. Conclusion Investors should stay away from cyclical sectors till the volatility subsides. SIPs can continue as planned since lower NAVs will mean more units getting purchased and the rupee cost averaging working in your favour.