Tag: inflation

Real vs. Nominal Returns

The One Rupee Banknote.

Image via Wikipedia

In my previous post about calculating returns, I briefly touched upon the notion of “risk adjusting” any projected returns to see if it makes sense compared to different investment options available. Today I’m going to discuss the biggest unavoidable risk of all: inflation.

Inflation is the erosion of value of money over time. i.e., as time progresses, the same Rupee buys less goods or services. We have all seen its effects first hand – I can’t think of single thing that has become cheaper over the years in India. So how does inflation affect investment decisions?

If you just took all your money and kept it in a vault, over a period of a year, you’ll get only 90% of it back. Where did the 10% go? Inflation took it (assuming a 10% annual inflation rate). Now imagine what happens if you socked away your money in a vault over a period of 10 years? How much will you get back then?

The rate of inflation plays a crucial role in calculating returns on investments. So important, in fact, that the way we calculated returns yesterday is called “nominal returns”. When you adjust nominal returns for inflation over the same period of time, you get “real returns.”

There are various measures of inflation depending on who it affects, but the most popular of them is the CPI – the Consumer Price Index. A good rule of thumb is to subtract nominal returns with the CPI to see how much you really end up making.

Different investments react differently to changes in inflation. For example, real assets, like real estate are supposed to be immune to inflation since their value is expected to rise along with it. Bonds perform poorly in an inflationary scenario because you get a fixed return. Stocks fall somewhere in between.

So its almost always a poor investment to keep cash in a vault. At the very least, your returns should at least match the rate of inflation.

NREGA is evil

Farmer plowing in Fahrenwalde, Mecklenburg-Vor...

Image via Wikipedia

I have always maintained that the Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA) is evil. Its evil both philosophically and by intent. It was sold as a scheme to create productive job opportunities for rural labor during the non-farming season and was supposed to be active in districts with acute unemployment problems. However, it has morphed into a major boondoggle.

I blame NREGA on our persistently high inflation and our seeming inability to grasp that  unproductive transfer payments always end in tears for the tax payers. And now, Morgan Stanley concurs:

This program has had an adverse impact on domestic inflation for three reasons:

  1. it discouraged workers to go to farms;
  2. local governments that did not have the administrative setup to run this program ended up transferring payouts to workers without getting the full productive utilization of the workers’ time; and
  3. those receiving these transfers ended up spending more on food (particularly protein items), since this represents a large proportion of their consumption basket.

Labour Bureau statistics indicate that, over the last three years, agricultural wages in India have risen by a cumulative 105%, compared with nominal GDP growth of 64% in the agriculture sector.

So the rural farm sector sees an unproductive increase in wages while the urban labor productivity weakens due to global economic slowdown and purchasing power decreases due to the Reserve Bank hiking rates 13 times in a row!

I call NREGA evil precisely because it prevents the movement of labor from unproductive sectors to productive ones. If the goal is to keep the poor unproductive and to pull down the lower middle classes back into poverty, then NREGA has been an unprecedented success. When will this madness end?

Inflation: its here!

World map showing inflation, updated for 2009....

Image via Wikipedia


Consumer price inflation in China quickened to 5.4% in the year to March, the fastest rate since July 2008, from 4.9% in the first two months of the year.


In India, the Wholesale Price Index, the main inflation gauge, rose 8.98% in the year to March, up from 8.31% in the 12 months to February.

Euro Area

Euro area inflation hits a fresh 29-month high of 2.7% year-on-year, up from 2.4% in Feb. and 1.6% a year ago. Expectations were for 2.6%. Month-on-month, inflation was +1.4%, the sharpest rise on record.


Bank of England policy maker Andrew Sentance said a slowdown in inflation may prove short-lived as the pound’s weakness threatens to push it above 5%.

Source: Reuters, Eurostat, Bloomberg

Enhanced by Zemanta