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Effects of Inflation on Indian Economy

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Inflation in the economy

The core Consumer Price Index or CPI inflation in India moves to an uncomfortable 5.52% in March as compared to 5.03% in February of 2021. A sharp rise in commodity prices, higher global inflation, depreciation of the currency and unexpected local lockdowns are worsening the higher price crises. 

This analysis highlights why the higher inflation could be India’s next worry amid and after the worsening covid crisis. 

Background to Inflation- 

In the most simplified way, inflation can be defined as the measure of the rate of rising prices of goods and services in an economy. The most obvious indicator of inflation is a skyrocketing increase in prices for the absolute necessities, this directly has a negative impact on the economy. 

There is no sector prevalent in the industry that is unprotected from the ill effects of inflation. Inflations can occur in any service or product including but not limited to real estate, pharmaceutical products, cosmetics, automobile and tourism. 

Once inflation becomes a recurring phenomenon, there is no guarantee that it will go back to normal. Inflation is a major concern because it reduces the value of the money saved today. Additionally, inflation systematically spoils the purchasing power of the customer. 

Inflation may not be an umbrella term for all things going wrong in the economy. Inflation is often considered important to maintain and drive consumption. Inflation keeps businesses profitable without making consumers wait for prices to fall to a certain level before they make a purchase.


Current Reasons for Inflation in India –

This is no news that the governments across the globe in response to the pandemic have increased their fiscal expenditures and India is not an exception. Additionally, the central banks have pumped in a lot of liquidity to drive through the uncertainties of lockdowns and pandemic. 

While the world is recovering from the wounds of the pandemic, the US inflation rate and economic policy decisions keep shifting the global trends. Higher global inflation would directly or indirectly result in an increase in domestic prices through dependency on the imported goods and services.

The Reserve Bank of India has new inflation worries as the rupee continues to depreciate against the US dollar. This sudden depreciation was a result of increasing prices of commodities and crude oil. The unexpected second Covid wave caused a major miscalculation in the banks’ inflation estimations. 

Additionally, RBI’s support to lower G-Sec yields to increase liquidity is eroding currency value and pushing inflation further. 

Fresh local lockdowns are expected to cause a long term dent in the Indian supply side. As covid cases and deaths pour out the local state and city governments are forced to impose curfews, lockdown and other restrictions. These governmental actions disrupt the supply chain movement leading to a price rise.

For the Indian economy right now, both micro and macro factors are working against systematically and resulting in increasing inflation. 

Key sectors affected by inflation – 

  • Aviation and hospitality- 

The yields of the aviation industry are decreased at an alarming rate because of the ongoing inflation. Inflation, as mentioned above leads to a steep increase in the prices of goods and services, reducing the purchasing power of consumers. The rise in prices of basic crude oil causes an increase in the cost of fuel and will directly result in a hike in ticket prices, cancellation of routes and a significant reduction in overall demand in the airline industry.

As a result of ever-increasing inflation, the spending capacity or the disposable income of the people reduces and they avoid taking pleasure trips or vacations in general in order to save and spend money on necessities. When people are not using the hospitality services like restaurants and hotels it directly affects the overall industry. Additionally, inflation also results in an increase in prices of land, food and wage rates which are crucial for the hospitality ecosystem to function.

Without major government support and policies targeted at the leisure and tourism industry, the overall industry suffers in the most obvious ways during the peak inflation cycle.

  • Automobile and its ancillary industries- 

Growing inflation is one of the most crucial issues that car manufacturers and buyers face. The rising cost of basic manufacturing equipment directly means that the consumer will have to pay more. The industry ecosystem faces the most backlash with commodity inflation, lower discounts, operating leverages and cost-cutting strategies. 

It is not just the manufacturing prices that skyrocket during the inflation, the loan interest rate also hikes. The higher interest rates have an impact on vehicle sales. Additionally, there can also be a shift in the taxation policies in the economy as an escape tool to manage inflation by the government which make taking out automobile loans even more difficult. 

With these factors affecting the buy and sell side of the automobile industry, inflation is a worry. 

  • Steel and other metals-

As mentioned earlier, metals along with agricultural commodities are the major culprits for inflationary issues across the globe. The price rise in the metal family is not just a result of high demand cycles but also a supply-side problem. There is an unquestionable rise in demand for steel and other metals resulting that policymakers want to double up their spendings and make room for developments. 

However, the big steel producers including Brazil reduced their production by at least 25%  which creates a tight supply chain leading to an acute shortage and thus the price rise while giants like China keep demanding more even with the expensive freight and export charges.

While the stimulus plans and packages are put in place by governments across the world to keep a continuous check on prices the medium to long term outlook suggests that the metal prices will continue to soar until situations and economic conditions return back to normal. 

  • Raw material linked industries like sugar, oil, grains- 

Regardless of the fact if you are a buyer or a manufacturer you may have recently witnessed a gradual but noticeable price increase across all product types. The most evident and crucial is the price rise in the aisles of your local supermarket. 

When increased raw material prices increase prices for consumers, the situation is known as cost-push inflation. The lockdowns across the globe forced labourers and manufacturers to stay at home, due to which there was a shortage and reduction of production capacity.

On the other hand, the consumers were stockpiling and increased their demand by 4%. This resulted in an imbalance in the system and led to a price rise across the raw material ecosystem including but not limited to sugar, refined oils, grains, pulses etc. 

Even though the government tries to keep checks and balances on increased prices in the food space, it is not possible to control and manage every small rise which makes it difficult to handle inflation. 

Measures of Inflation

Conclusion – 

Overall, a rise in price or inflation to some extent points towards a struggling economy. Inflation erodes the purchasing power of the consumers greatly. It also decreases the value of savings along with depreciating the currency value.

Additionally, inflation attracts more inflation and is troublesome for all the players of the market in some way or another. 

That said, the commodity stocks stand to benefit from rising inflation. The well-known commodity Gold will be the biggest beneficiary of rising inflation as it acts as a hedge against inflation.

Other commodity (such as steel, iron, and copper stocks) stocks also stand to benefit due to high inflation. Investors can consider keeping the following stocks under the radar to benefit from rising inflation:

  1. Gold ETF
  2. Tata Steel BSL
  3. NMDC
  4. Vedanta
  5. Hindustan Zinc
  6. SAIL
  7. Tata Steel

One must note that investing in commodity stocks during an upcycle is not at all recommended, only short term traders can take the benefit of high volumes & volatility to enter and exit at appropriate levels. 

For commodities – Buy when the commodity price is low, hold during the downturn & take partial exits during upcycles. Only then, wealth can be generated in these stocks.

Disclaimer – The analysis is only for educational purposes. Do not consider the analysis as a stock recommendation. 

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