Inflation is defined as an overall increase in general price levels of goods and services within the economy. In other words, it is an increase in cost of living. Inflation is still the most neglected concept by the common man while building a retirement plan. Factoring the effects of inflation on your financial portfolio is extremely important as an unanticipated inflation can erode the purchasing power of your personal wealth.
In India, inflation is calculated as an annualized change in Wholesale Price Index (WPI) which includes a set of around 435 goods, unlike the Consumer Price Index (CPI) used by the rest of the world. Inflation figures based on WPI is considered to be understated as consumers pay prices higher that the wholesale prices.
Inflation results when too much money ends up purchasing too few goods. This happens when either the money supply flowing in the economy increases, or there is some supply constraint. The most common reason of inflation during modern times has been the increase in money supply. For the purpose of stimulating GDP growth in times of economic slowdown, the Indian government maintained loose monetary policies. Interest rates were maintained at low levels which increases disposable income in the hands of the citizens. Moreover, soaring crude oil prices also fueled inflationary pressure.
At the same time, mounting deficits and manufacturing overcapacity and threats of real estate bubbles cannot overrule the hyperinflationary trends in the future. Another crucial factor which continues to be ignored by policy makers in India is ‘Food Inflation’. Fast rising population coupled with slowing production capacity of cultivable land in the country could leas to hyperinflationary trends. Poor yield owing to water shortage and lack of adequate irrigation infrastructure has forced many farmers to quit agriculture and shift to other occupations. Without a credible and long-term strategy to boost land productivity, inflation over the long term cannot be avoided.