Chapter 6
6Inflation
Inflation is the silent force that turns nominal safety into real loss. This chapter separates real return from nominal return, explains purchasing power, and shows why savings accounts are useful for liquidity but insufficient for long-term wealth.
Real return
Example: if a fixed deposit earns 7 per cent and inflation is 6 per cent before tax, the true gain is small; after tax it may disappear. Real return asks what the money can buy, not what the statement says.
Real return is return after removing Indian inflation. It measures change in purchasing power, not change in account balance.
Inflation-adjusted growth
Approximate real return is nominal return minus inflation. Exact real return accounts for compounding:
\[ \text{real return}=\frac{1+r}{1+i}-1. \]Plan in real terms
- Use real return for long-term planning.
- A positive nominal return can still be a negative real return.
- Taxes reduce real return further.
1973 - Oil shock
The global oil price shock pushed inflation higher in many countries. It is a useful reminder that inflation can come from supply shocks, not only from excess demand.
Nominal return
Example: a mutual fund showing 12 per cent and a deposit showing 7 per cent are nominal figures before adjusting for inflation and tax. Nominal return is the label; real purchasing power is the substance.
Nominal return is the visible percentage gain before inflation adjustment.
Nominal return is useful for statements and comparison over a fixed period, but incomplete for decisions. It is like measuring motion without specifying the reference frame.
Do not stop at statement return.
- Record nominal return, but decide using real return.
- Compare products over the same period and tax treatment.
- Do not celebrate return without checking purchasing power.
Purchasing power
Example: a monthly grocery basket that cost INR 5,000 can become INR 7,000 over time even if the rupee notes look identical. Purchasing power is the quantity of real goods and services your money commands.
Purchasing power is the quantity of goods and services INR can buy in India.
If expenses double in fifteen years, a corpus that did not grow has lost half its practical force. Inflation differs across categories, so education and medical goals may need higher assumptions than general household expenses.
Inflate the goal.
- Estimate future goals in inflated cost.
- Keep long-term money in assets that can grow with the economy.
- Review assumptions because inflation differs by category.
Why savings account alone is not enough
Example: a savings account is excellent for payments and immediate liquidity, but weak as a long-term wealth store. If all long-term money remains there, inflation quietly transfers value away from the saver.
An Indian savings account gives liquidity and operational safety. It is essential for transactions and emergency access.
Storage is not growth
Savings accounts are usually below inflation after tax. For long horizons, using only a savings account is like storing energy in a leaky container.
Separate safety and growth.
- Use savings accounts for transactions and emergency access.
- Move long-term surplus into suitable investments.
- Keep safety money safe; keep growth money growing.
1991 - India balance-of-payments crisis
India faced severe external stress and had to reform its economic policy framework. For investors, the episode shows why purchasing power, currency pressure, and macro stability matter.
