Over the dinner table, families often muse over the past. Once, my father said, “In the 70s, when we saw the “Sholay” in the theatre, the ticket price was just Rs 4.5”. I quickly added, “Now, it costs Rs 200 per ticket at the multiplex!”.
In the last 46 years, the ticket price was up by 45 times or 8.6 per cent annually; this statistic surprised everyone assembled for a meal.
Inflation is nothing but such a rate of rise in annual prices. And, when we hear about consumer inflation, it is a rise in the price level as compared to a year before – of a basket of consumer items.
Any wealth creation strategy requires realistic assumptions on inflation expectations. It serves as the hurdle rate for the portfolio returns to cross, in order to preserve wealth.
Let’s look at some historical trends of inflation in India.
The 1950s – All under control
After gaining independence in 1947, for the whole of the 1950s, the inflation remained subdued – averaging less than 2 per cent.
However, there was a lot of variation; inflation was -12.8% (deflation that is) in 1952-53 when there was higher agricultural output while it went up to 13.8% in 1956-57 due to demand pressures and measures for industrialization.
However, at the end of the decade, inflation was under control and in the range of 3-7%.
The 1960s – War and famine effect
In the 1960s, inflation levels were up and averaged about 6 per cent.
India fought two wars – with China (in 1962) and Pakistan (in 1965) – which resulted in the diversion of government revenues towards defence as against industrialization or economic development.
Also, twin droughts in 1965 and 1966 created severe food shortages and stoked food inflation. From 1964-67, prices rose at double-digit rates. By the end of the decade, however, inflation cooled down and was even negative in 1969 aided by a bumper crop and Green revolution initiatives.
The 1970s – High rise
The 70s were perhaps the most tumultuous period in terms of inflationary uncertainty.
Inflation averaged 7.5% on average in the 1970s. International crude oil prices were up by over 250 per cent in 1974 amidst the first oil shock of 1973.
And for the first time since independence, inflation crossed 20% in 1973-74. Heavy dependence on oil imports resulted in higher domestic fuel prices with its spillover effects on other consumer products. When crude oil prices cooled, the drought of 1979-80 increased inflation rates.
The 1980s – Printing money
In the 80s, the inflation was even higher – averaging 9.2% p.a. – due to the expansionary fiscal policies of the government and its monetization.
The central government’s fiscal deficit – the gap between the revenues and spends – widened from 3.8 per cent of GDP in the 1970s to 6.8 per cent in the 1980s. And this fiscal gap was bridged by printing more currency which in turn added to demand pressures and inflation.
Moreover, there were imbalances in the foreign account with rising current account deficits (more imports than exports), after international trade was partially liberalized in the 1980s.
1990s – Post-reform effect
A severe economic crisis happened in 1991 triggered by a balance of payment problem emanating from an adverse impact of high fiscal and current account deficits of the 1980s.
During the crisis year of 1991, inflation was 13.9 per cent. To counter grave economic problems, the Government came up with a spate of economic reforms – financial, external, and industrial.
It led to large foreign capital inflows in the initial years resulting in a higher-than-normal monetary expansion in the economy. Inflation continued to be high for a few years – from 1992-1996 – when it averaged 9.5 per cent. Later it came down sharply (5.4 per cent) over the next decade (1996-2005) as structural reforms started bearing fruit. Despite the drought of 2002-03, the adequate release of surplus stock of food grains kept a check on food prices.
The 2000s and beyond – Lofty persistence
From 2003 onwards, when the economy started growing at 7% plus annual rates, inflation inched up. It culminated in the inflation rate crossing double digits in 2009 and 2010, after crude oil prices hit an all-time high of $ 147 per barrel in July of 2008.
Surprisingly, even the 2008 global financial crisis couldn’t cool off inflation. Between 2008 and 2013, inflation averaged 10.1% p.a due to the rising global oil and metal prices. The drought of 2009 stoked food prices while higher demand for protein-based products like eggs, fish and milk (thanks to increasing per-capita income levels) created protein inflation of a structural nature.
To put the economy back on track, the Government announced several fiscal stimulus packages in 2008 and 2009 which increased the fiscal deficit once again – thereby putting pressure on prices.
However, since 2014, inflation levels were down with the economic slowdown and as demonetization and GST measures got implemented.
In 2020, amidst pandemic, inflation increased to 6.6%. For the month of May 2021, CPI inflation was at 6.3% on the back of a sharp rise in food, transport and fuel prices.
What to expect going forward?
Post-reforms of 1991-92, consumer inflation has averaged 7 per cent. Recently, the Government, in consultation with the RBI, retained the inflation target at 4 per cent for the 5-year period (FY 2022-2026) with the lower and upper tolerance levels of 2 per cent and 6 per cent respectively.
So, one can expect consumer inflation to be 4-6% annually over the medium term. If it starts rising further, RBI might consider measures to bring it within the acceptable band of 2-6%. However, if the past is any indication, inflation can also be persistently high despite monetary or fiscal measures, as it happened between 2008 and 2013.
So, it might be prudent to assume that 7% consumer inflation is a possibility while working out investment strategies. Moreover, keep in mind your family’s actual spending pattern when deciding on inflation expectations for your investment portfolio.
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