Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. Inflation is the loss of purchasing power of the money. Eg. If Rajesh was able to buy 1KG fruits for Rs.100 before two months and now suddenly the price of same 1Kg fruits have become Rs.115 all other factors remaining unchanged then this is called Inflation.
Inflation is inevitable but a high inflation rate is not desirable as it could lead to economic uneasiness. A high level of inflation tends to send a bad signal to markets. Governments work towards cutting down the inflation to a manageable level. Inflation is measured by WPI (Wholesale price index) & CPI (Consumer price index).
WPI captures the price increase or decrease when goods are sold between institutions as against actual consumers. Since the inflation measured here is at an institutional level it does not necessarily capture the inflation experienced by the consumer.
CPI captures the effect of the change in prices at retail level. The calculation of CPI is relatively detailed as it involves categorizing consumption into various categories and sub categories across rural and urban regions. Each of these categories is considered into an index. So the CPI index is a work of several internal indices.CPI index is published every month by Ministry of Statistics and Programme implementation (MOSPI). This number has impact on the markets.
Gross domestic product (GDP) is the monetary value of all the finished goods & services produced within a country’s boards in a specific period of time. GDP indicates the overall health of an economy.GDP calculation includes public as well as private consumption, government expenses, investments & export minus imports that occur in an economy. Its calculation formula is
GDP = C + G + I + NX C=consumption in an economy G=government spending in the economy I=Total investments in the economy NX =(Export –Imports) in an economy It gives an idea of the overall economic progress of the country GDP (+) = Economic Activity Rising GDP (-) = Economic Activity Falling
Balance of payment is the record of all the transactions between a country & other world economy during a specific period of time. It is the account of a country’s international transactions. BOP account is broken into three categories namely current account, capital account & financial account.
Current account includes any exchange of goods and services between two countries. E.g. If India exports goods to U.S then the amount which U.S will pay for the goods are credited to India’s account & the same amount is debited from U.S BOP account.
Capital account records the capital going in & out of a country for capital investment purposes. E.g. If a U.S resident migrates to India the assets which he moves from U.S to India are credited to India’s BOP account & debited from U.S balance of payment account.
Financial account records the payment flow concerning to the change in the ownership of international financial assets & liabilities this could include direct, portfolio investment or reserved assets investments by the monetary authorities of the countries. Eg., If India invests into foreign securities of U.S then the amount invested will be debited from India’s BOP account & credited to U.S BOP account.
A country’s BOP figure should be ideally zero. The current account should balance with capital account plus financial account. But due to exchange rate fluctuation & economical disturbance idealistic situation is often not true. But this figure helps the country to identify any long term trend which could be disturbing to an economy. Current account deficit is when countries imports are more than its exports so the income to the country in foreign currency is less than its expenses in foreign currency and this negative difference between imports & exports is called current account deficit.
INCOME: Export income, Income from foreign investment, Money sent by Indians(NRIs) working abroad & Interest earned on debt given to foreign countries.
EXPENSES: Import expenses, Payment to foreign investors, Money sent to home countries by foreigners working in India & Interest paid on interest taken from foreign countries.
INCOME – EXPENSE = + VE CURRENT ACCOUNT SURPLUS INCOME – EXPENSE = - VE CURRENT ACCOUNT DEFICIET
CURRENT ACCOUNT SURPLUS (+) OR Good Sign of the economy CURRENT ACCOUNT DEFICIET (-)
CURRENT ACCOUNT SURPLUS (-) OR Not Good Sign of the economy CURRENT ACCOUNT DEFICIET (+)
ii. CAPITAL ACCOUNT: Capital account records the capital going in & out of a country for capital investment purposes. E.g. If a U.S resident migrates to India the assets which he moves from U.S to India are credited to India’s BOP account & debited from U.S balance of payment account.
IIP measures the production in the Indian industrial sectors. Ministry of Statistics and Programme implementation publishes this data every month. 15 different industries submit their production data to the ministry, which collates the data and releases it as an index number. If the IIP is increasing it indicates a vibrant industrial environment and therefore a positive sign for the economy and markets. A decreasing IIP indicates a slow production environment, thus a negative sign for the economy and markets.
When economy is in bad phase with less GDP & IIP numbers such as industrialization is sluggish the employment rate in an economy goes down. Thus increasing unemployment number is a negative indication about the economy’s progress & thus affects the investor sentiments & markets.
Every country has a central bank like Reserve bank of India (RBI) whose function is to create a balance between the Growth & inflation in the economy. RBI controls the money supply in the country by controlling interest rates.
How RBI maintains a balance between growth & inflation by controlling the interest rates is explained as follows:
a. If RBI raises the interest rates then the borrowings for the corporate becomes expensive if corporations don’t borrow then they cannot grow. If the corporations don’t grow the economy slows down.
b. If the RBI decreases the interest rate then the borrowings become cheaper for the corporate thus more money in the hands of corporations & consumers. With more money people tend to spend more & thus the suppliers increase the prices of the goods.
So RBI has to decide the interest rates in such a way to strike a balance between growth & inflation.
Some of the important rates which RBI decides in its quarterly review are as follows:
a. Repo rate: The rate at which RBI lends money to other banks is called the repo rate. If repo rate is high that means the cost of borrowing is high, leading to a slow growth in the economy.
b. Reverse repo rate: Reverse Repo rate is the rate at which RBI borrows money from banks. When banks choose to lend money to the RBI, the supply of money in system reduces. An increase in reverse repo rate is negative for economy as it tightens the money supply.
These rates are release by RBI on the quarterly basis and this is the key event which can have positive as well as negative impact on the market