Inflation in India: Some Real Numbers

Published: May 20, 2014 at 12:58 pm

Last Updated on

My wife hates personal finance! If I want her out of the room, all I need to do is to utter words/phrases like, freefincal, goal-based investing, CAGR, retirement planning (most effective!), just about anything that is not metallic, shiny and yellow in colour!

Therefore, you can imagine my surprise when she handed me a diary and said, “write a post on inflation with this”!

It was a diary of monthly accounts maintained by my parents from Jan. 1995 (to Jan. 2006 when we took over after my late fathers illness). We have records before that as well, all the way down to the 1950s maintained by my grandfather. Will try and dig those up someday.

Here are some inflation figures obtained by comparing individual entries in our Jan 1995 budget with May 2014 budget.

We will then compare these figures with those obtained from an analysis of the cost inflation index.

I have calculated this with a simple CAGR formula:

price in May 2014 =  price in Jan 1995 x (1+ inflation)^(time elapsed)

Therefore,

Inflation = (price in May 2014 / price in Jan 1995)^(1/time-elased) -1

The time elapsed is in years – 19.34 in this case

In 1995, we were a family of three. Mom and dad were working and I was in B. Sc final year. In 2014, we are a family of 3 adults (self, spouse, mom) and my four year son.

I have assumed that consumption and nature of expenses have remained the same.

This is debatable but just about reasonable in our case as we have always been pretty frugal.

Some expenses have disappeared  – video rentals, and new ones have cropped up – internet usage. TV viewing was high in 1995, computer(s) usage is high in 2014 (with near zero TV). We have one AC now.

So for calculating inflation in electricity I have subtracted Rs. 1000 from today’s fee.

So here goes,

Inflation in india real numbers

 

Our flat is a small one, just 9 houses. So maintenance inflation is pretty low. It is an old building with no car park or elevator.

Provisions have more or less remained the same, except for olive oil usage. More on that here.

Cable TV. This again is low. We don’t watch TV at all. Have a slim CRT set kept in one corner of our hall. No HD subscription. Just a bouquet with a reasonable number of channels.

Milk consumption has been the same. We drink a lot of coffee though!

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Cooking gas consumption the same. This is important as global factors play a role on this and petrol expenses.

Coming to which, petrol expenses surprisingly same! By dad drove a two wheeler in 95. I do so now. My wife has one, which she barely uses.

Electricity in Tamil Nadu has become quite expensive now. Service has increased tremendously but supply is poor and available only at a premium.

We never had a problem paying a good salary to our paid-help. Inflation affects them too – much, much more.

Look at that vegetable inflation! This is a cause for concern as it depends on monsoons – El Nino!  We never use onions too much!

The overall inflation obtained with total expenses is a relatively comfortable 7.8%

What can we infer from these numbers? 

We need to use at least 8% inflation in our retirement and financial goal planning calculations. Note that 8% is for a frugal family with practically no entertainment expenses!

What a minute! By using a CAGR formula, I have completed ignored fluctuations in inflation.

When returns fluctuate, they make sense only if we know the corresponding standard deviation.

So we will need to study the fluctuations in inflation to get an idea about what standard deviation to use.

For this, we will use cost inflation index. There is a lot of debate about how the CII is not a good enough tool to represent inflation.

Now that we have some real inflation figures, let us find out, how good CII is in reflecting household inflation.

CII Analysis

Using cost inflation index data from here, the rolling CAGR was calculated for durations ranging from 1 year to 26 years.

CII is set to 100 for FY 1981-82. So if we wish to calculate CAGR for every 1Y period from then to FY 2013-14, we will have 32 data points, which we will average.

Similarly, if we wish to calculate CAGR for every possible 26 year durations, we will have 7 data points, which we will average. Let me know if you need the corresponding Excel file.

This average of the rolling CAGR and the corresponding standard deviation (measure of deviation from the average) is plotted as a function of duration.

inflation-rolling

 

Surprisingly, the average rolling CAGR depends little on the durations. It is about ~ 7.25% whether you the duration is 1Y or 26Y.

Unsurprisingly, the standard deviation sharply decreases and tends to ~ 0.25% with an increase in the duration.

What does this tell us?

  • For long term goals, a minimum inflation of 7% should be used, 8% would be better.
  • On a year on year basis, average inflation is ~ 7% but can fluctuation as much as 2.5%. That is 68 times out of 100, it can range from 7- 2.5 = 4.5% to 7+ 2.5 = 9.5%.
  • This is important for early retirees. This kind of fluctuations implies that the net portfolio return after taxes must be at least 8% if not more for early retirement. Easier said than done with volatile asset classes like equity and bonds.
  • This is of course the overall inflation. Inflation for different commodities and different services can deviate from this average significantly.
  • Do not take comfort in the 7% average. Always keep in mind that the actual overall  inflation can swing from this by as much as 2.5%. Could be more as this is only an approximation!
  • Even for a frugal family like us, the overall inflation is 7.8% -. This is much higher than the average of the rolling CAGR.
  • Therefore, unless a family cuts down on unnecessary expenditure, it will be difficult for them to handle retirement. Remember to beware of you!

Most families keep a record of budgets past. If you can locate yours, calculate the long-term inflation rate. It will give you a better perspective on retirement planning and goal-planning in general.

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Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com

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57 Comments

  1. I didn’t able to see the search box to findout the post by key words. I can in mobile view. Is there any problem with my desktop browser?

  2. I didn’t able to see the search box to findout the post by key words. I can in mobile view. Is there any problem with my desktop browser?

  3. Thanks for sharing. Now the 8% used in retirement calculators has a factual meaning instead of just being a ‘random’ number.

  4. Thanks for sharing. Now the 8% used in retirement calculators has a factual meaning instead of just being a ‘random’ number.

  5. Dear Ashok, 7.25% id inflation data from CII. 7.7%isactual data for dear Pattu’s family while he lives frugally. For the current young guns who live pay check to pay check, a 10% is a better number.

    thanks

    Ashal

      1. Dear Ashal and Pattu,

        Totally agree that the inflation number applies only if we can maintain a similar standard of living as we live now (or at least be prepared to climb down to this standard if the financial situation demands).

  6. Dear Ashok, 7.25% id inflation data from CII. 7.7%isactual data for dear Pattu’s family while he lives frugally. For the current young guns who live pay check to pay check, a 10% is a better number.

    thanks

    Ashal

      1. Dear Ashal and Pattu,

        Totally agree that the inflation number applies only if we can maintain a similar standard of living as we live now (or at least be prepared to climb down to this standard if the financial situation demands).

  7. The number you have arrived at is pure inflation number. But note that our quality of life also improves and this has its own inflation. The 1000 rupee you deducted from electricity usage is an example of this. This should NOT be ignored. For your child, you may need to buy laptop/iPad for school soon. This is something you didn’t have 10 yeras back. So, it is better to add 2% more to the numeric inflation when you plan.

    1. Good point. Thank you. When we speak of inflation it has be only with respect to needs at some point in history with respect to the same needs now. If you have a new expense now, the rate at which it grows will be known only in the future. So I agree with you that it is best to plan with as high an inflation as one can possibly afford.

  8. The number you have arrived at is pure inflation number. But note that our quality of life also improves and this has its own inflation. The 1000 rupee you deducted from electricity usage is an example of this. This should NOT be ignored. For your child, you may need to buy laptop/iPad for school soon. This is something you didn’t have 10 yeras back. So, it is better to add 2% more to the numeric inflation when you plan.

    1. Good point. Thank you. When we speak of inflation it has be only with respect to needs at some point in history with respect to the same needs now. If you have a new expense now, the rate at which it grows will be known only in the future. So I agree with you that it is best to plan with as high an inflation as one can possibly afford.

  9. I stick to 10% as a base. Somehow after reading “Lords of Finance: The Bankers who broke the world”, i’ve become paranoid about hyperinflation hitting India.

  10. I stick to 10% as a base. Somehow after reading “Lords of Finance: The Bankers who broke the world”, i’ve become paranoid about hyperinflation hitting India.

  11. I also endorse the views of some of the valuable comments wherein 10% is suggested which is safer to assume. In India, inflation is somewhat like an ‘untamed’ elephant which can suddenly turn funny and cranky !! Accounting for this and the general feel and habit of living better in the last 2 decades, I think a 10% sustainable long-term inflation is quite realistic for India. Moreover, pls. note that with high import content of energy and global markets and prices beyond our control, currency can go for a toss which will put higher pressure on inflation since oil is an all-pervading commodity with its inflation piercing all cost components and living !! Thanks.

  12. I also endorse the views of some of the valuable comments wherein 10% is suggested which is safer to assume. In India, inflation is somewhat like an ‘untamed’ elephant which can suddenly turn funny and cranky !! Accounting for this and the general feel and habit of living better in the last 2 decades, I think a 10% sustainable long-term inflation is quite realistic for India. Moreover, pls. note that with high import content of energy and global markets and prices beyond our control, currency can go for a toss which will put higher pressure on inflation since oil is an all-pervading commodity with its inflation piercing all cost components and living !! Thanks.

  13. 10 years is a relatively short period from which to extrapolate. It’s interesting that those are also the high growth years of early economic liberalization. It’s questionable whether the 1995-2006 period is truly representative of future inflation. I just can’t imagine a society with 8-10% inflation into perpetuity remaining stable. Something will have to give.

    1. If you reread the post, you will recognise the duration is from Jan 1995 to May 2014. As long as India depends on monsoons, inflation will be high. As long as it does not control oil reserves inflation will be high.

  14. 10 years is a relatively short period from which to extrapolate. It’s interesting that those are also the high growth years of early economic liberalization. It’s questionable whether the 1995-2006 period is truly representative of future inflation. I just can’t imagine a society with 8-10% inflation into perpetuity remaining stable. Something will have to give.

    1. If you reread the post, you will recognise the duration is from Jan 1995 to May 2014. As long as India depends on monsoons, inflation will be high. As long as it does not control oil reserves inflation will be high.

  15. after going through the comments, again i bring the point of our love for round number . in the previous case, it was a benchmark for expected returns, now it is in the case of inflation. just an observation.

  16. after going through the comments, again i bring the point of our love for round number . in the previous case, it was a benchmark for expected returns, now it is in the case of inflation. just an observation.

  17. after going through the comments, again i bring the point of our love for round number . in the previous case, it was a benchmark for expected returns, now it is in the case of inflation. just an observation.

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