Inflation - The silent killer

When it comes to complaining about rising vegetable prices, we are in good company - even the Prime Minister's wife does it. That is not however the reason why the Reserve Bank of India aggressively monitors inflation.

Inflation is basically a measure of prices in the country. It is measured by something called the WPI - wholesale price index, which factors in prices of basic goods and commodities in India. It is usually indicated in percentage terms. So if the WPI is 5.6%, then it means that wholesale prices have risen by 5.6% over the same date last year.

But even if inflation sounds like yet another burden that common people have to deal with, for the banking and financial system players, inflation is the centre of their universe. The reason: inflation erodes the value of money and hence the return on investment.

If inflation is 4%, it means that a lunch costing Rs 100 last year will cost your Rs 104 today. Hence your Rs 100 should have grown by Rs 4 in one year for you to enjoy the same standard of living. Hence for you to have a 'real' return on your investment of Rs 100, the interest rate should be more than 4%.

Hence when inflation rises, interest rates need to rise to ensure that investors get 'real returns'. Rising interest rates means:

• the cost of loans for both companies and individuals increase.
• falling asset prices thereby reducing the value of individual and corporate assets - be it land, homes, shares, bonds, gold - almost immediately.

Hence rising inflation numbers tend to scare off investors in bonds and shares since the value of their portfolio declines.

The examples and simplicity elicited just give the importance of inflation. Many a times - it is proved - that the destruction caused by inflation is many times more than dropping a 100 nuke bombs....

Thanks for the patience and wait for my next blog on "The Wonderful feelings of being a father"...

Cheers and GOD bless all!!