What is Inflation, Its Types and How Does It Impact your Investment?

Types of Inflation

There are different kinds of inflation, each of which is defined by its leading cause or rate of growth:

• Cost-push: The cost of manufacturing products & services rises leading to a rise in prices. Common examples include an increase in the cost of labour and raw materials leading to inflation.

• Demand-pull: When the demand for products and services exceeds what can be produced at the time, prices increase.

• Deflation: A negative inflation rate, leading to a decrease in prices of goods and services, is the opposite of inflation.

• Disinflation: A pause in the increase of prices for goods and services or a decline in inflatio

• Reflation: Government deliberately stimulates the economy by boosting the money supply or government spending. Additionally, when a government lowers interest rates, inflation may result.

• Creeping: Low or mild inflation, with annual price increases of less than 3%.

• Walking (trotting): While prices gradually increase, the annual inflation rate remains low.

• Running (galloping): At an inflation rate of over 10% per year, prices rise significantly into the double digits.

• Hyperinflation: Over 1,000% annual inflation is extraordinary and spinning out of control.

• Stagflation: A high rate of inflation that occurs during a period of economic recession.

Current Inflation Rate

Based on the Wholesale Price Index (WPI), the annual inflation rate for all of India in May 2023 is estimated to be 4.25%. In April 2023, the annual rate of inflation was 4.75%. This reduction in inflation is at least in part due to cuts in excise duty on crude oil and diesel, as well as reduction of import duty on edible oils and various raw materials. In addition to this, recent RBI policies have also played a part in reducing liquidity in markets, which has led to reduced inflation even though other factors like GST rates have remained unchanged.   

How Does Inflation Affect Your Investments?

Depending on the sort of investment, inflation may have a different effect. For example, inflation can hurt the performance of assets that provide payouts at a predetermined interest rate on yearly like, like traditional bonds, treasury bills, or bank certificate of deposits (CDs).

Inflation may or may not adverse impact returns from equities. While the economy is strong and inflation is on the rise, bubsinesses might be selling more, which would boost the value of their stock. Although this lowers their value, businesses will also have to pay more for labour and raw supplies. The corporation's success in holding a stock can determine whether inflation will assist or hinder it.

On the other hand, when inflation has been high historically, precious commodities like gold have fared well, so including gold investments in your portfolio can help hedge you against inflation risk. Finally, certain assets have their inflation risk indexed. Their income is steadier because it increases with rising inflation and decreases with falling inflation. This function is available in some floating rate bonds and annuities for an additional fee.

How to Choose Investments that Beat Inflation 

One of the best strategies for consumers to beat inflation is investing in assets that offer higher returns than the inflation rate. For example, experts often advise investing in diversified index funds based on broad market indices as well as other types of equity investments for long-term wealth creation. Choosing a mix of these and other suitable investment options in India lowers your risk of losing money because of inflation and allows you to engage in asset allocation in order to diversify your portfolio.

The earlier you invest and the longer you stay invested, regardless of where the market may be when you start, the better. This is because compounding returns—when you reinvest your gains to earn even more—allow you to make more money over time. So even though no one can accurately predict how the market will move in future, one of the best methods to fight inflation is to invest wisely in particular assets for the long term.

Conclusion

It doesn’t matter what goes well or bad in the world; inflation will always be concerning. A person's money will be safe and grow due to wise decisions. Otherwise, we know that inflation would do what it is meant to do—drain bank accounts. A better understanding of inflation is a must for this generation.

Frequently Asked Questions (FAQs)

Q1. Why is inflation necessary?

As per most economists, inflation at low to moderate levels, if stable and predictable can help in providing long term economic growth. However, too much or unpredictable changes in inflation can hamper economic growth in the short and long term.  

Q2. How does CPI and WPI inflation compare?

The Wholesale Price Index WPI inflation and the Consumer Price Index CPI inflation are regularly employed and valuable measures for determining the country's inflation. The WPI is a metric used to determine the price fluctuations of wholesale-marketable items.

Q3. What is the inflation index that will be used to correlate inflation rates?

The inflation rate in India is on final combined Consumer Price Index (CPI), with 2010 as the base year.

Q4. Is the Inflation Indexed National Savings Securities-Cumulative (IINSS-C) open to everyone who wants to invest?

Individuals of the Hindu Undivided Family (HUF), nonprofit organizations registered under Section 25 of the Indian Companies Act. Also, universities under Central, State, and Provincial Acts or designated universities under Section 3 of the University Grants Commission Act, 1956, can invest in inflation-indexed national savings securities – cumulative (IINSS-C).

Q5. What is demand-pull inflation?

When there is a shortage of supplies as compared to their demand, it results in a rise of process termed as demand-pull inflation. In this situation, extra money has to be spent for buying the same quantity of items.