Inflation’s impact on average investor | The Financial Express

Inflation’s impact on average investor

While low/moderately low levels of inflation may be good for the economy, high inflation is bad news for you as a consumer and as an investor.

Inflation’s impact on average investor
How, as an average retail investor, can you subdue the brunt of soaring inflation and rising interest rates?

By Neha Juneja, CEO, IndiaP2P.com

Inflation rates have been soaring across the globe, and it’s likely that you felt the pinch of rising expenses.

In the United States, Inflation is at a 40-year high, and the scenario is not so different in other countries.

While low/moderately low levels of inflation may be good for the economy, high inflation is bad news for you as a consumer and as an investor. Let’s understand how inflation affects the average investor.

Let’s start by taking a look at the financial and economic forces behind inflation, and how the governments and central banks respond to it.

We’ll also cover how, as an average retail investor you can subdue the brunt of soaring inflation and rising interest rates.

What is Inflation?

In simple terms, inflation is an overall increase in the prices of goods and services in an economy.

It is pretty obvious, and we all face its impact as consumers all the time.

Over time, the purchasing power of currencies falls. You could’ve bought a piece of land for as little as Rs 10 back in the 1940s, and now, you can hardly get a pack of snacks for the same amount.

When we think of inflation in the long run, it seems like an apparent phenomenon to us. Then why does inflation become such a big issue every now and then?

In 2010 there was a hue and cry in the Indian households owing to a tremendous surge in onion prices in just a matter of months.

In Venezuela, inflation is so high that artefacts made of Venezuelan currency notes are more valuable than the face value of the banknotes. In the last 40 years, inflation in Venezuela moved between 6.3 per cent and 1,30,060 per cent. In 2020 itself, the country registered an inflation rate of over 2959 per cent!

You need a pile of cash just to buy a roll of toilet papers.

The picture was quite the same in post-depression Germany, where carts loaded with cash were not enough to afford a loaf of bread.

The table below gives you an overview of how CPI (Consumer Price Index) inflation has moved between 3.33 per cent and 11.99 per cent in India during the period 2010- 2020.

Table containing year wise inflation.

Now during the same period Fixed Deposit rates have declined steadily. There was a time when FD returns touched as high as 14 per cent, in fact, just about 10 years ago in 2011-12 1-year FD rates in India averaged around 9.13 per cent.

However, fixed deposits are barely able to cover inflationary loss in the present scenario. Interest offered by savings accounts is in the range of 4-5 per cent which technically means you lose money over time.

I hope you are able to fathom the impact inflation can have on your pocket as well as your quality of life. So much so that it often triggers a regime change in democratic countries. And this is why authorities try to keep it in control.

Let’s understand what causes inflation and the economic forces behind it.

What Causes Inflation?

Market forces of supply and demand are the two major drivers of inflation.

When the demand for something increases, and the supply is unable to catch up with it, it leads to an increase in the price.

This is a basic principle of economics, when demand increases but supply remains the same, or worse decreases, it leads to a rise in the prices.

You can easily visualise this. Imagine two scenarios. In the first you have 10 cars and 10-20 potential buyers, now due to reasons that we will discuss in a bit, the number of potential buyers increases to 100, while the supply of cars remains the same, or worse, drops to 8 due to supply chain constraints.

Instinctively, the car seller will increase the prices of the cars, so only a few of the prospective 100 people are able to afford one.

Now there can be several reasons behind increasing demand and decreasing or stagnant supply.

Quantitative easing is one of the major reasons behind an increase in overall demand.

Let’s understand this with the help of the present scenario.

In 2020, when the COVID-19 pandemic hit and the resulting lockdowns ensued, it resulted in an economic slowdown. This was pretty obvious, and economists and authorities had rightly predicted it.

Several steps were taken by the governments and central banks across the world in oder to boost economic activity and prevent businesses from dying out.

Among other things, pushing the demand was one of the primary goals of the authorities.

The Central banks resorted to quantitative easing, increasing the money supply in the economy by lower the interest rates, so the businesses as well as consumers borrow more and spend more.

In May 2020, the Reserve Bank of India reduced the repo rate (a key lending rate of the central bank) and kept it at the same level for almost two years.

Central Banks also resorted to printing out more and more money in order to increase the money flow. Literally printing out more money!

In fact, the US Federal Reserve printed a whooping $3 trillion in just three and half months in 2020.

More money in the economy means more money for the consumers to spend. Thus resulting in a surge in demand.

Now, on the other hand, the pandemic resulted in a major supply chain disruption across the globe with ships fillers with goods docked at ports for months. This and an increase in the cost of raw materials resulted in slack in the supply of goods and services.

High demand and low (or stagnant) supply resulted in an increase in prices.

There are many other macroeconomic reasons that have been building up for almost a decade now, that triggered the high inflation rates in some major economies. However, these were the immediate ones that provoked the fallout.

How does the Government Control Inflation?

Controlled inflation is good! In fact, it’s a sign of economic growth and progress. However, when inflation rates go out of control and are not brought under control in a timely manner, it disrupts the economy.

Central banks respond to high inflation rates by hiking the lending rates. These banks keep on changing the lending rates from time to time, and this is an effective way of controlling the money supply and overall trend in economic activity.

After two years of quantitative easing, the Reserve Bank of India has now turned to quantitative tightening by hiking the interest rates.

When the Central bank raises the interest rates, loans become costlier resulting in lesser lending activity in the economy, which helps in reducing the money supply and consequently the demand.

However, this also slows down the economy. Costlier loans impact the businesses’ finances and this is why the stock market tumbles every time the RBI announces a rate hike.

Soaring inflation rates, costlier raw materials and now, costlier loans. These are the prime reasons behind the stock market slowdown we are now experiencing.

Inflation impacts everyone’s portfolio, be it, retail investors or seasoned players. However, average investors are less equipped to soothe the mayhem.

There are several alternative investment options that can help average investors beat inflation. One such avenue is high-yield P2P lending. P2P Lending enables you to invest in loans and earn regular interest income. With RBI regulated platforms such as IndiaP2P you can earn up to 16% p.a. by investing in ready loan portfolios.

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First published on: 26-08-2022 at 20:38 IST