EFFECT OF INFLATION IN INDIAN STOCK MARKET
Inflation is the surge in the average prices of goods and services for a longer duration in the economy. This reduce the purchasing power of money; value of money is reduced. There are mainly 3 types of inflations in the economy.
- Demand-Pull Inflations – increase in the total demand of commodities causes this inflation. The main causes of are Rise in population, Black money, Rise in income, and Excessive government expenditure.
- Cost-Push Inflations– is the overall prices hike due to increases in production costs. it is caused by the factors like Increase in price of inputs, hoarding and Speculation of commodities, defective Supply chain, increase in indirect taxes, depreciation of Currency, crude oil price fluctuation etc.
- Built-in Inflations – when the workers demand high wages, the company is forced to increase the cost of goods and services for the customers. This is called built-in Inflations.
Measurement of inflation
- Wholesale Price Index (WPI) – the change in price of the commodity is measured in the stages before the retail level. It is measured when goods that are sold in bulk and traded between entities or businesses instead of consumers. This is the most popular method of measuring inflation in India.
- Consumer Price Index (CPI) – it measures the change in prices of most common goods and services used by consumers.
- Producer Price Index (PPI) – there is no index to measure inflation at producer level in India.
How does inflation affect Indian stock market?
- Increased interest rate– when there is an increase in inflation rate there will be an increase in interest rate. This results in decrease in the value of bonds, equities and debt. When the interest rates go up, the cost of capital also goes up. So the future cash flows of the company will be valued lower.
- Decreased purchasing power of investors – when the inflation rate increase, the value of money decrease. Thus the purchasing power of the investor is reduced. A reduction in purchasing power has a negative impact on the consumer-driven stocks.
- Effect on stocks – there are two type of stocks, value stocks and growth stocks. Value stocks have strong cash flows whereas growth stocks have little or no cash flow. Increased inflation rates have a negative impact on growth stocks where as a positive impact on value stocks. The effect of Inflation on stocks that pay dividends or income-generating stocks is negative. Because Inflation makes them less attractive as the dividends are not enough to cope up with increased Inflation levels.
- Impact on Sensex and Nifty – when the value of money goes down, people have less savings. The investors have fewer cash holdings and the investment in the stock market will also go down.