Inflation and Its Impact on Stock Market and Company_s Economic Growth

ABV-Indian Institute of Information Technology and Management, Gwalior

Inflation and its impact on Stock Market and Company’s Economic Growth

A THESIS REPORT

SUBMITTED BY

Vimarsh Kapoor

2007MBA-46

UNDER THE ESTEEMED GUIDANCE

OF

Dr. Deepali Singh

(Associate Prof.)

FOR

THE PARTIAL FULFILLMENT OF THE REQUIREMENT OF

Master of Business Administration 2007-09

AT

ABV-Indian Institute of Information Technology & Management, Gwalior

0 | P a g eVimarsh Kapoor


CONTENTS

Abstract……………………………………………………………………………………….6

Chapter 1:

Introduction............................................................................................................................81.1 Inflation …….... .. ...............................................................................................................8

1.2 Deflation…………….......................................................................................................8

1.3 Disinflation………………………………………………………………………………9

1.4 Anticipated and Unanticipated Inflation……………………………………………......10

Chapter 2: Inflation Rate Calculation and different Indexes……………………………………….11

2.1 WPI calculation................................................................................................................12

2.2 CPI…………...................................................................................................................13

2.3 Inflation Rate calculation.................................................................................................14

2.4 Units of Inflation………………………………………………………………………17

Chapter 3:

Inflation Types and its measures………………..………………………………………19

3.1 Types of Inflation……………………………………………………………………...20

3.2 Measures of Inflation……………………………………..……………………………22

Chapter 4:

Inflation and Stock Market................................................................................................31

4.1 Global Market……………………………………………………………………..……33

4.2 Impact of Inflation on conditional stock market volatility…………..……………….35

4.3 Inflation impact on Stock Market……………………………………………………..37



Chapter 5:

Inflation impact on different Sectors................................................................................41

5.1 Inflation impact on FMCG Sector……………………………………………………..43

5.2 Inflation impact on Telecom Sector……………………… ………………………..44

5.3 Inflation impact on Banking Sector……… …………………………………………..46

Chapter 6:

Literature Review...........................................................................................................48

Chapter 7:

Research Methodology ………….…………………………………………….………50

Chapter 8:

Data Analysis………………........................................................................................54

References…………………………………………………………………………….58.

Questionnaire………………………………………………………………………….60



CERTIFICATE

TO WHOMSOEVER IT MAY CONCERN

The project study entitled “Inflation and its impact on Stock Market and

Company’s Economic Growth” submitted by Vimarsh Kapoor (Roll No

2007MBA-46) in partial fulfillment of the Master of Business Administration

2007-09 is a record of original work carried out by me under the guidance and

supervision of Dr Deepali Singh. This is to certify that the work has not been

submitted elsewhere for any award of any degree or diploma.

Vimarsh Kapoor Dr. Deepali Singh

Roll No 2007MBA-46 (Project Guide)



ACKNOWLEDGEMENT

I take this opportunity of thanking everyone who has contributed towards the

fulfillment of this project. Firstly, I express my sincere gratitude to my project

guide, Dr. Deepali Singh, for her invaluable advice, and constant support and

encouragement throughout the course of this project.

I am also grateful to the faculty of ABV-IIITM for their guidance. I am thankful to

the computer lab and library staff for their unfailing assistance.

I am grateful to all my friends who helped me with their suggestions, opinions and

criticism.

Vimarsh Kapoor

Roll No 2007MBA-46



Abstract

The intention of this thesis is to examine the impact of the inflation rate on the performance of companies and stock market. Particular attention is to be paid on the effects of the rate of inflation on various companies performance variables, in terms of market activity and market liquidity, also to find out what are the major factors that causes inflation rate to fluctuate and why Indian and European markets suffers from it differently. Also different indexes are undertaken to better understand how these indexes make their impact on inflation to grow or decline, and different methods to calculate the inflation rate. It is also reflected through the work that what are the various ways through which inflation rate can be kept under control.



Chapter 1Introduction



Introduction

1.1 Background

Inflation rate of a country is the rate at which prices of goods and services increase in its economy. It is an indication of the rise in the general level of prices over time. Since it’s practically impossible to find out the average change in prices of all the goods and services traded in an economy (which would give comprehensive inflation rate) due to the sheer number of goods and services present, a sample set or a basket of goods and services is used to get an indicative figure of the change in prices, which we call the inflation rate.

The term "inflation" usually refers to a measured rise in a broad price index that represents the overall level of prices in goods and services in the economy. The Consumer Price Index (CPI), the Personal Consumption Expenditures Price Index (PCEPI) and the GDP deflator are some examples of broad price indices. The term inflation may also be used to describe the rising level of prices in a narrow set of assets, goods or services within the economy, such as commodities (which include food, fuel, metals), financial assets (such as stocks, bonds and real estate), and services (such as entertainment and health care). The Reuters-CRB Index (CCI), the Producer Price Index, and Employment Cost Index (ECI) are examples of narrow price indices used to measure price inflation in particular sectors of the economy. Asset price inflation is a rise in the price of assets, as opposed to goods and services. Core inflation is a measure of price fluctuations in a sub-set of the broad price index which excludes food and energy prices. The Federal Reserve Board uses the core inflation rate to measure overall inflation, eliminating food and energy prices to mitigate against short term price fluctuations that could distort estimates of future long term inflation trends in the general economy.

Deflation A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.

Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and


http://en.wikipedia.org/wiki/Federal_Reserve_Board

http://en.wikipedia.org/wiki/Federal_Reserve_Board

http://en.wikipedia.org/wiki/Core_inflation

http://en.wikipedia.org/wiki/Goods_and_services

http://en.wikipedia.org/wiki/Goods_and_services

http://en.wikipedia.org/wiki/Asset_price_inflation

http://en.wikipedia.org/wiki/Employment_Cost_Index

http://en.wikipedia.org/wiki/Producer_Price_Index

http://en.wikipedia.org/wiki/Reuters-CRB_Index

http://en.wikipedia.org/wiki/Financial_asset

http://en.wikipedia.org/wiki/Commodity

http://en.wikipedia.org/wiki/GDP_deflator

http://en.wikipedia.org/wiki/Personal_consumption_expenditures_price_index

http://en.wikipedia.org/wiki/Consumer_Price_Index


increasing defaults on loans by companies and individuals. To counter deflation, the Federal Reserve (the Fed) can use monetary policy to increase the money supply and deliberately induce rising prices, causing inflation. Rising prices provide an essential lubricant for any sustained recovery because businesses increase profits and take some of the depressive pressures off wages and debtors of every kind.

Disinflation A slowing of the rate at which prices increase. Typically, this occurs during a recession as sales drop and retailers are not able to pass on higher prices to customers.There is widespread agreement that high and volatile inflation can be damaging both to individual businesses and consumers and also to the economy as a whole.The problems of a wage-price spiral – price rises can lead to higher wage demands as workers try to maintain their real standard of living. Higher wages over and above any gains in labour productivity causes an increase in unit labour costs. To maintain their profit margins they increase prices. The process could start all over again and inflation may get out of control. Higher inflation causes an upward spike in inflationary expectations that are then incorporated into wage bargaining. It can take some time for these expectations to be controlled.

Inflation can also cause a reduction in the real value of savings - especially if real interest rates are negative. This means the rate of interest does not fully compensate for the increase in the general price level. In contrast, borrowers see the real value of their debt diminish. Inflation, therefore, favours borrowers at the expense of savers. Inflation can also cause a disruption of business planning – uncertainty about the future makes planning difficult and this may have an adverse effect on the level of planned capital investment.

Budgeting becomes a problem as firms become unsure about what will happen to their costs. If inflation is high and volatile, firms may demand a higher nominal rate of return on planned investment projects before they will go ahead with the capital spending.



These hurdle rates may cause projects to be cancelled or postponed until economic conditions improve. A low rate of new capital investment clearly damages long-run economic growth and productivity. Cost-push inflation usually leads to a slower growth of company profits which can then feed through into business investment decisions.

Inflation distorts the operation of the price mechanism and can result in an inefficient allocation of resources. When inflation is volatile, consumers and firms are unlikely to have sufficient information on relative price levels to make informed choices about which products to supply and purchase.

Anticipated and unanticipated inflation

When inflation is volatile from year to year, it becomes difficult for individuals and businesses to correctly predict the rate of price inflation that will happen in the near future. When people are able to make accurate predictions of inflation, they can anticipate what is likely to happen and take steps to protect themselves. For example, people can bid for increases in money wages so as to maintain their real wages. Savings can be shifted into accounts offering a higher rate of interest, or into assets where capital gains might outstrip general price inflation. Companies can adjust their prices; lenders can adjust interest rates.

Unanticipated inflation occurs when economic agents (people, businesses and governments) make errors in their inflation forecasts. Actual inflation may end up well below, or significantly above expectations.



Chapter 2

Inflation Rate Calculation and different Indexes

Mathematically, inflation or inflation rate is calculated as the percentage rate of change of a certain price index. The price indices widely used for this are Consumer Price Index (adopted by countries such as USA, UK, Japan and China)



and Wholesale Price Index (adopted by countries such as India). Thus inflation rate, generally, is derived from CPI or WPI. Both methods have advantages and disadvantages. Since India uses WPI method for inflation calculation, let’s go in to the details of WPI based inflation calculation

How is WPI (Wholesale Price Index) calculated?In this method, a set of 435 commodities and their price changes are used for the calculation. The selected commodities are supposed to represent various strata of the economy and are supposed to give a comprehensive WPI value for the economy.

WPI is calculated on a base year and WPI for the base year is assumed to be 100. To show the calculation, let’s assume the base year to be 1970. The data of wholesale prices of all the 435 commodities in the base year and the time for which WPI is to be calculated is gathered.

Let's calculate WPI for the year 1980 for a particular commodity, say wheat. Assume that the price of a kilogram of wheat in 1970 = Rs 5.75 and in 1980 = Rs 6.10

The WPI of wheat for the year 1980 is,(Price of Wheat in 1980 – Price of Wheat in 1970)/ Price of Wheat in 1970 x 100

i.e. (6.10 – 5.75)/5.75 x 100 = 6.09

Since WPI for the base year is assumed as 100, WPI for 1980 will become 100 + 6.09 = 106.09.

In this way individual WPI values for the remaining 434 commodities are calculated and then the weighted average of individual WPI figures are found out to arrive at the overall Wholesale Price Index. Commodities are given weight-age depending upon its influence in the economy.

Consumer Price Index



A consumer price index (CPI) is a measure of the average price of consumer goods and services purchased by households. It is a price index determined by measuring the price of a standard group of goods meant to represent the typical market basket of a typical urban consumer.Related, but different, terms are the CPI, the RPI, and the RPIX used in the United Kingdom. It is one of several price indices calculated by most national statistical agencies. The percent change in the CPI is a measure of inflation. The CPI can be used to index (i.e., adjust for the effects of inflation) wages, salaries, pensions, or regulated or contracted prices. The CPI is, along with the population census and the National Income and Product Accounts, one of the most closely watched national economic statistics.

Two basic types of data are needed to construct the CPI: price data and weighting data. The price data are collected for a sample of goods and services from a sample of sales outlets in a sample of locations for a sample of times. The weighting data are estimates of the shares of the different types of expenditure as fractions of the total expenditure covered by the index. These weights are usually based upon expenditure data obtained for sampled decades from a sample of households. Although some of the sampling is done using a sampling frame and probabilistic sampling methods, much is done in a commonsense way (purposive sampling) that does not permit estimation of confidence intervals. Therefore, the sampling variance is normally ignored, since a single estimate is required in most of the purposes for which the index is used. Stocks greatly affect this cause.

Ideally, the weights would relate to the composition of expenditure during the time between the price-reference month and the current month. There is a large technical economics literature on index formulae which would approximate this and which can be shown to approximate what economic theorists call a true cost of living index. Such an index would show how consumer expenditure would have to move to compensate for price changes so as to allow consumers to maintain a constant standard of living. Approximations can only be computed retrospectively, whereas the index has to appear monthly and, preferably, quite soon. Nevertheless, in some countries, notably in North America and Sweden, the philosophy of the index is that it is inspired by and approximates the notion of a true cost of living (constant utility) index, whereas in most of Europe it is regarded more pragmatically

Example: The prices of 95,000 items from 22,000 stores, and 35,000 rental units are added together and averaged. They are weighted this way: Housing: 41.4%, Food and Beverage: 17.4%, Transport: 17.0%, Medical Care: 6.9%, Other: 6.9%,


http://en.wikipedia.org/wiki/Cost_of_living_index

http://en.wikipedia.org/wiki/Cost_of_living_index

http://en.wikipedia.org/wiki/List_of_price_index_formulas

http://en.wikipedia.org/wiki/Sampling_(statistics)

http://en.wikipedia.org/wiki/Sampling_(statistics)

http://en.wikipedia.org/wiki/National_Income_and_Product_Accounts

http://en.wikipedia.org/wiki/National_Income_and_Product_Accounts

http://en.wikipedia.org/wiki/Census

http://en.wikipedia.org/wiki/Pension

http://en.wikipedia.org/wiki/Inflation

http://en.wikipedia.org/wiki/Price_index


http://en.wikipedia.org/wiki/United_Kingdom

http://en.wikipedia.org/wiki/RPIX

http://en.wikipedia.org/wiki/Retail_Price_Index_(United_Kingdom)

http://en.wikipedia.org/wiki/Consumer_Price_Index_(United_Kingdom)


Apparel: 6.0%, Entertainment: 4.4%. Taxes (43%) are not included in CPI computation

How is inflation rate calculated?

If we have the WPI values of two time zones, say, beginning and end of year, the inflation rate for the year will be,

(WPI of end of year – WPI of beginning of year)/WPI of beginning of year x 100

For example, WPI on Jan 1st 1980 is 106.09 and WPI of Jan 1st 1981 is 109.72 then inflation rate for the year 1981 is,

(109.72 – 106.09)/106.09 x 100 = 3.42% and we say the inflation rate for the year 1981 is 3.42%.

Since WPI figures are available every week, inflation for a particular week (which usually means inflation for a period of one year ended on the given week) is calculated based on the above method using WPI of the given week and WPI of the week one year before. This is how we get weekly inflation rates in India.

Characteristics of WPI

Following are the few characteristics of Wholesale Price Index WPI uses a sample set of 435 commodities for inflation calculation The price from wholesale market is taken for the calculation WPI is available every week It has time lag of two weeks, which means WPI of the week two weeks back

will be available now

Latest Inflation Rate- 2009 Apr 11 - 0.26%



(for 12 months ended on the given date)

Previous Inflation Rates (for 12 months ended on given date)- 2009 Apr 04 - 0.18% - 2009 Mar 28 - 0.26%- 2009 Mar 21 - 0.31%- 2009 Mar 14 - 0.27%- 2009 Mar 07 - 0.44%- 2009 Feb 28 - 2.43%- 2009 Feb 21 - 3.03%- 2009 Feb 14 - 3.36%- 2009 Feb 7 - 3.92%- 2009 Jan 31 - 4.39%- 2009 Jan 24 - 5.07%- 2009 Jan 17 - 5.64%- 2009 Jan 10 - 5.60%- 2009 Jan 3 - 5.24%

This is the unsorted list of countries by inflation rate. The list is based on the CIA World Factbook data and is updated according to the statistical updates by respective countries. Dependent territories and not fully recognized states are not ranked.


http://en.wikipedia.org/wiki/CIA_World_Factbook


Rank Country Inflation rate(consumer prices) (%)

Date ofinformation

1 Nauru -3.60 1993

2 San Marino -1.50 2006

— Northern Mariana Islands -0.80 2000

3 Burkina Faso -0.20 2007 est.

4 Japan 0.10 2007 est.

5 Niger 0.10 2007 est.

6 Kiribati 0.20 2007 est.

7 Brunei 0.40 2007 est.

8 Israel 0.50 2007 est.

9 Switzerland -0.80 Feb[2] 2009 est.

10 China 1.00[14] Jan 2009 est.

11 United States 4.20 2008 est.

12 Germany 0.40[11] March 2009 est.

13 India 0.26 [16] March 2009 est.

14 Indonesia 7.92[15] Apr 2009 est.

Units of inflationInflation rate is usually measured in percent per year. It can also be measured in percent per month, or in price doubling time

New Price y years later = Old Price *(1+ inflation/100)^y


http://en.wikipedia.org/wiki/Inflation_rate

http://en.wikipedia.org/wiki/List_of_countries_by_inflation_rate#cite_note-Reuters-14%23cite_note-Reuters-14

http://en.wikipedia.org/wiki/Indonesia

http://en.wikipedia.org/wiki/List_of_countries_by_inflation_rate#cite_note-News_Agency-15%23cite_note-News_Agency-15

http://en.wikipedia.org/wiki/India

http://en.wikipedia.org/wiki/List_of_countries_by_inflation_rate#cite_note-Bloomberg-10%23cite_note-Bloomberg-10

http://en.wikipedia.org/wiki/Germany

http://en.wikipedia.org/wiki/United_States

http://en.wikipedia.org/wiki/List_of_countries_by_inflation_rate#cite_note-Channel_News_Asia-13%23cite_note-Channel_News_Asia-13

http://en.wikipedia.org/wiki/People's_Republic_of_China

http://en.wikipedia.org/wiki/List_of_countries_by_inflation_rate#cite_note-Dailyfx-1%23cite_note-Dailyfx-1

http://en.wikipedia.org/wiki/Switzerland

http://en.wikipedia.org/wiki/Israel

http://en.wikipedia.org/wiki/Brunei

http://en.wikipedia.org/wiki/Kiribati

http://en.wikipedia.org/wiki/Niger

http://en.wikipedia.org/wiki/Japan

http://en.wikipedia.org/wiki/Burkina_Faso

http://en.wikipedia.org/wiki/Northern_Mariana_Islands

http://en.wikipedia.org/wiki/San_Marino

http://en.wikipedia.org/wiki/Nauru

http://en.wikipedia.org/wiki/List_of_countries_by_inflation_rate





Monthly inflation = 100 *((1+inflation/100)^1/12 – 1)

Price doubling time = log2/log(1+ inflation/100)

Years per added zero of the price = 1/log(1+ inflation/100)

Example of inflation rates and unitsWhen first bought, an item cost 1 currency unit. Later, the price rose...

Old price

New price 1 year later

New price 10 years later

New price 100 years later

(Annual)

inflation [%]

Monthlyinflation

[%]

Pricedoublingtime[years]

Zero add time [years]

1 1.001 1.01 1.11 0.1 0.00833 2300

1 1.003 1.03 1.35 0.3 0.0250 769

1 1.01 1.10 2.70 1 0.0830 .7 231

1 1.03 1.34 19.2 3 0.247 .4 77.9

1 1.1 2.59 13800 10 0.797 .27 24.1

1 2 1024 1.27 × 1030 100 5.95 3.32

1 10 1010 10100 900 21.2 .301 (3⅔ months) 1

1 31 8.20 × 1014 1.37 × 10149 3000 32.8 .202 (2½ months)0.671 (8 months)

1 1012 10120 101,200 1014 900 .0251 (9 days)0.0833

(1 month)

11.67 × 1073 1.69 × 10732 1.87 × 107,322 1.67 × 1.26 × 108 .00411 (36 hours) 0.0137



1075 (5 days)

11.05 × 102,637 1.69 × 1026,370 1.89 × 10263,702

1.05 × 102,6395.65 × 10221 .000114 (1 hour)

0.000379 (3.3

hours)



Chapter 3Inflation Types and its Measures

Types of Inflation

Biflation is the state of an economy where the processes of inflation and deflation occur simultaneously. During this period there is a rise in the purchasing prices of commodity items and a fall in the purchasing prices of non-commodity items.The purchasing price of an item is based on the demand for it and the amount of money in circulation to pay for it. Biflation is preceded by an overabundance of money placed in circulation within the population by a central bank. Since commodities (such as food, energy, clothing) are essential and are in high demand, the purchase price for them rises due to the increased money available to buy them. This increasing purchase amount is price inflation. One reason is liquidity flees to the safest and most liquid assets. This causes the money supply at upper levels of the pyramid to shrink while the money supply at lower levels of the pyramid expands. This causes deflation as the money supply evaporates away. Likewise, biflation is


http://en.wikipedia.org/wiki/Central_bank

http://en.wikipedia.org/wiki/Money

http://en.wikipedia.org/wiki/Commodity

http://en.wikipedia.org/wiki/Deflation


http://en.wikipedia.org/wiki/Economy


preceded by a decrease in employment within the population. Although there is an increase of money in circulation, fewer people have access to the money to make purchases. As a result, a greater percentage of individual wages is directed toward purchasing commodities and less is utilized for purchasing non-commodity items. Since debt-based assets (such as automobiles, televisions, stocks) are less essential and are in lower demand, the purchase price for them falls due to the decreased money available to buy them. This decreased purchase amount is price deflation.

Chronic inflation is characterized by much higher price increases than ordinary inflation, at annual rates of 10% to 30% in some industrialized nations and even 100% or more in a few developing countries. Chronic inflation tends to become permanent and ratchets upwards to even higher levels as economic distortions and negative expectations accumulate. To accommodate chronic inflation, normal economic activities are disrupted: Consumers buy goods and services to avoid even higher prices; property speculation increases; businesses concentrate on short-term investments; incentives to acquire savings, insurance policies, pensions, and long-term bonds are reduced because inflation erodes their future purchasing power; governments rapidly expand spending in anticipation of inflated revenues; exporting nations suffer competitive trade disadvantages forcing them to turn to protectionism and arbitrary currency controls.

Inflation originally referred to the debasement of the currency. When gold was used as currency, gold coins could be collected by the government (e.g. the king or the ruler of the region), melted down, mixed with other metals such as silver, copper or lead, and reissued at the same nominal value. By diluting the gold with other metals, the government could increase the total number of coins issued without also needing to increase the amount of gold used to make them. When the cost of each coin is lowered in this way, the government profits from an increase in seigniorage. This practice would increase the money supply but at the same time lower the relative value of each coin. As the relative value of the coins decrease, consumers would need more coins to exchange for the same goods and services. These goods and services would experience a price increase as the value of each coin is reduced.


http://en.wikipedia.org/wiki/Seigniorage

http://en.wikipedia.org/wiki/Currency_controls

http://en.wikipedia.org/wiki/Protectionism

http://en.wikipedia.org/w/index.php?title=Short-term_investment&action=edit&redlink=1

http://en.wikipedia.org/w/index.php?title=Short-term_investment&action=edit&redlink=1

http://en.wikipedia.org/wiki/Speculation

http://en.wikipedia.org/wiki/Consumer

http://en.wikipedia.org/wiki/Developing_countries

http://en.wikipedia.org/wiki/Industrialized_nation


http://en.wikipedia.org/wiki/Deflation

http://en.wikipedia.org/wiki/Wages

http://en.wikipedia.org/wiki/Employment


By the nineteenth century, economists categorized three separate factors that cause a rise or fall in the price of goods: a change in the value or resource costs of the good, a change in the price of money which then was usually a fluctuation in metallic content in the currency, and currency depreciation resulting from an increased supply of currency relative to the quantity of redeemable metal backing the currency. Following the proliferation of private bank note currency printed during the American Civil War, the term "inflation" started to appear as a direct reference to the currency depreciation that occurred as the quantity of redeemable bank notes outstripped the quantity of metal available for their redemption. The term inflation then referred to the devaluation of the currency, and not to a rise in the price of goods.

This relationship between the over-supply of bank notes and a resulting depreciation in their value was noted by earlier classical economists such as David Hume and David Ricardo, who would go on to examine and debate to what effect a currency devaluation (later termed monetary inflation) has on the price of goods (later termed price inflation, and eventually just inflation).

Measures of Inflation

Inflation is usually measured by calculating the inflation rate of a price index, usually the Consumer Price Index.[14] The Consumer Price Index measures prices of a selection of goods and services purchased by a "typical consumer".[15] The inflation rate is the percentage rate of change of a price index over time.

For example, in January 2007, the U.S. Consumer Price Index was 202.416, and in January 2008 it was 211.080. The formula for calculating the annual percentage rate inflation in the CPI over the course of 2007 is

(211.080 -202.416)/202.416 = 4.28%


http://en.wikipedia.org/wiki/Inflation#cite_note-14%23cite_note-14


http://en.wikipedia.org/wiki/Consumer_Price_Index

http://en.wikipedia.org/wiki/Inflation_rate

http://en.wikipedia.org/wiki/Monetary_inflation

http://en.wikipedia.org/wiki/David_Ricardo

http://en.wikipedia.org/wiki/David_Hume

http://en.wikipedia.org/wiki/David_Hume

http://en.wikipedia.org/wiki/American_Civil_War

http://en.wikipedia.org/wiki/Bank_note

http://en.wikipedia.org/wiki/Value_(economics)


The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the general level of prices for typical U.S. consumers rose by approximately four percent in 2007.[16]

Other widely used price indices for calculating price inflation include the following:

Cost-of-living indices (COLI) are indices similar to the CPI which are often used to adjust fixed incomes and contractual incomes to maintain the real value of those incomes.

Producer price indices (PPIs) which measures average changes in prices received by domestic producers for their output. This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any eventual increase in the CPI. Producer price index measures the pressure being put on producers by the costs of their raw materials. This could be "passed on" to consumers, or it could be absorbed by profits, or offset by increasing productivity. In India and the United States, an earlier version of the PPI was called the Wholesale Price Index.

Commodity price indices, which measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee.

Core price indices: because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore most statistical agencies also report a measure of 'core inflation', which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy.

Other common measures of inflation are:

GDP deflator is a measure of the price of all the goods and services included in Gross Domestic Product (GDP). The US Commerce Department publishes a deflator series for US GDP, defined as its nominal GDP measure divided by its real GDP measure.


http://en.wikipedia.org/wiki/Gross_Domestic_Product

http://en.wikipedia.org/wiki/GDP_deflator

http://en.wikipedia.org/wiki/Monetary_policy

http://en.wikipedia.org/wiki/Central_bank

http://en.wikipedia.org/wiki/List_of_national_and_international_statistical_services


http://en.wikipedia.org/wiki/Commodity_price_index

http://en.wikipedia.org/wiki/Wholesale_price_index

http://en.wikipedia.org/wiki/Wholesale_price_index

http://en.wikipedia.org/wiki/Producer_price_index

http://en.wikipedia.org/wiki/Real_versus_nominal_value

http://en.wikipedia.org/wiki/Real_versus_nominal_value

http://en.wikipedia.org/wiki/Cost-of-living_index



Regional inflation The Bureau of Labor Statistics breaks down CPI-U calculations down to different regions of the US.

Historical inflation Before collecting consistent econometric data became standard for governments, and for the purpose of comparing absolute, rather than relative standards of living, various economists have calculated imputed inflation figures. Most inflation data before the early 20th century is imputed based on the known costs of goods, rather than compiled at the time. It is also used to adjust for the differences in real standard of living for the presence of technology.

Asset price inflation is an undue increase in the prices of real or financial assets, such as stock (equity) and real estate. While there is no widely-accepted index of this type, some central bankers have suggested that it would be better to aim at stabilizing a wider general price level inflation measure that includes some asset prices, instead of stabilizing CPI or core inflation only. The reason is that by raising interest rates when stock prices or real estate prices rise, and lowering them when these asset prices fall, central banks might be more successful in avoiding bubbles and crashes in asset prices.

Issues in measuring

Measuring inflation in an economy requires objective means of differentiating changes in nominal prices on a common set of goods and services, and distinguishing them from those price shifts resulting from changes in value such as volume, quality, or performance. For example, if the price of a 10 oz. can of corn changes from $0.90 to $1.00 over the course of a year, with no change in quality, then this price difference represents inflation. This single price change would not, however, represent general inflation in an overall economy. To measure overall inflation, the price change of a large "basket" of representative goods and services


http://en.wikipedia.org/wiki/Economic_bubble

http://en.wikipedia.org/wiki/Real_estate

http://en.wikipedia.org/wiki/Stock

http://en.wikipedia.org/wiki/Assets_inflation


is measured. This is the purpose of a price index, which is the combined price of a "basket" of many goods and services. The combined price is the sum of the weighted average prices of items in the "basket". A weighted price is calculated by multiplying the unit price of an item to the number of those items the average consumer purchases. Weighted pricing is a necessary means to measuring the impact of individual unit price changes on the economy's overall inflation. The Consumer Price Index, for example, uses data collected by surveying households to determine what proportion of the typical consumer's overall spending is spent on specific goods and services, and weights the average prices of those items accordingly. Those weighted average prices are combined to calculate the overall price. To better relate price changes over time, indexes typically choose a "base year" price and assign it a value of 100. Index prices in subsequent years are then expressed in relation to the base year price.

Inflation measures are often modified over time, either for the relative weight of goods in the basket, or in the way in which goods and services from the present are compared with goods and services from the past. Over time adjustments are made to the type of goods and services selected in order to reflect changes in the sorts of goods and services purchased by 'typical consumers'. New products may be introduced, older products disappear, the quality of existing products may change, and consumer preferences can shift. Both the sorts of goods and services which are included in the "basket" and the weighted price used in inflation measures will be changed over time in order to keep pace with the changing marketplace.

Inflation numbers are often seasonally adjusted in order to differentiate expected cyclical cost shifts. For example, home heating costs are expected to rise in colder months, and seasonal adjustments are often used when measuring for inflation to compensate for cyclical spikes in energy or fuel demand. Inflation numbers may be averaged or otherwise subjected to statistical techniques in order to remove statistical noise and volatility of individual prices.

When looking at inflation economic institutions may focus only on certain kinds of prices, or special indices, such as the core inflation index which is used by central banks to formulate monetary policy.


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Effects

Negative

An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services.[17] The effect of inflation is not distributed evenly, and as a consequence there are hidden costs to some and benefits to others from this decrease in purchasing power. For example, with inflation lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers benefit. Individuals or institutions with cash assets will experience a decline in the purchasing power of their holdings. Increases in payments to workers and pensioners often lag behind inflation, especially for those with fixed payments.[8]

High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation.[8] Uncertainty about the future purchasing power of money discourages investment and saving.[18] And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates.

With high inflation, purchasing power is redistributed from those on fixed incomes such as pensioners towards those with variable incomes whose earnings may better keep pace with the inflation.[8] This redistribution of purchasing power will also occur between international trading partners. Where fixed exchange rates are imposed, rising inflation in one economy will cause its exports to become more expensive and affect the balance of trade. There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.

Cost-push inflation

Rising inflation can prompt employees to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the


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case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward trend. This can cause a wage spiral.[19] In a sense, inflation begets further inflationary expectations.

Hoarding

people buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects.

Hyperinflation

if inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply.

Allocative efficiency

a change in the supply or demand for a good will normally cause its price to change, signalling to buyers and sellers that they should re-allocate resources in response to the new market conditions. But when prices are constantly changing due to inflation, genuine price signals get lost in the noise, so agents are slow to respond to them. The result is a loss of allocative efficiency.

Shoe leather cost

High inflation increases the opportunity cost of holding cash balances and can induce people to hold a greater portion of their assets in interest paying accounts. However, since cash is still needed in order to carry out transactions this means that more "trips to the bank" are necessary in order to make withdrawals, proverbially wearing out the "shoe leather" with each trip.

Menu costs

With high inflation, firms must change their prices often in order to keep up with economy wide changes. But often changing prices is itself a costly


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activity whether explicitly, as with the need to print new menus, or implicitly.

Business cycles

According to the Austrian Business Cycle Theory, inflation sets off the business cycle. Austrian economists hold this to be the most damaging effect of inflation. According to Austrian theory, artificially low interest rates and the associated increase in the money supply lead to reckless, speculative borrowing, resulting in clusters of malinvestments, which eventually have to be liquidated as they become unsustainable.[20]

PositiveLabor-market adjustments

Keynesians believe that nominal wages are slow to adjust downwards. This can lead to prolonged disequilibrium and high unemployment in the labor market. Since inflation would lower the real wage if nominal wages are kept constant, Keynesian argue that some inflation is good for the economy, as it would allow labor markets to reach equilibrium faster.

Debt relief

Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the inflation rate. (R=n-i) For example if you take a loan where the stated interest rate is 6% and the inflation rate is at 3%, the real interest rate that you are paying for the loan is 3%. It would also hold true that if you had a loan at a fixed interest rate of 6% and the inflation rate jumped to 20% you would have a real interest rate of -14%. Banks and other lenders adjust for this inflation risk either by including an inflation premium in the costs of lending the money by creating a higher initial stated interest rate or by setting the interest at a variable rate.

Room to maneuver

The primary tools for controlling the money supply are the ability to set the discount rate, the rate at which banks can borrow from the central bank, and



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open market operations which are the central bank's interventions into the bonds market with the aim of affecting the nominal interest rate. If an economy finds itself in a recession with already low, or even zero, nominal interest rates, then the bank cannot cut these rates further (since negative nominal interest rates are impossible) in order to stimulate the economy - this situation is known as a liquidity trap. A moderate level of inflation tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the bank can cut the nominal interest rate.

How is Inflation controlled by the Government

If inflation looks to be getting too high, then they will raise interest rates. This affects businesses and consumers.

1. Consumers will find it more attractive to save more and spend less. They will find it more expensive to borrow money for spending. Most consumers also have mortgages. The repayments become more expensive so their disposable income falls and they spend less. Overall, spending in the economy falls.

2. Businesses find it more expensive to borrow money for investment and growth. Investment spending is also spending in the economy, and this falls.

Of course, there is a cost to this, because growth and employment are reduced, so the Bank has to weigh this up carefully. If inflation looks too low, it cuts interest rates with the opposite effect, and growth and employment are increased.

How Inflation can be Prevented

Basically, inflation is rising prices, so anything that stops prices rising will make inflation less likely.


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1. Competition. If there is a lot of competition in a market, businesses try harder to keep prices low to keep buyers.

2. Elasticity of demand. If goods are elastic, buyers will resist price rises. Elasticity is related to substitutability, so if there are plenty of substitutes, then buyers will simply switch spending away from the more expensive products. Imports are a kind of substitute. Competition leads to more choice, so this affects substitutes as well.

3. Elasticity of supply. If businesses can increase output without increasing costs, then price rises are less likely. For example, economies of scale make sellers keen to actually cut costs to expand output and sales.

4. If output rises, businesses buy more inputs, so we need to think of the elasticities of supply and demand in these markets as well, not just finished products. As businesses buy more inputs, these prices may stay much the same, or start to rise which puts up business costs. Wages are especially important because wages can be a very large business cost, and because the labour market isn’t quite the same as the potato market.

5. Labour causes particular problems.

- Wages are ‘sticky’ downwards. If there are too many potatoes on the market, the price falls until buyers decide to buy again. But workers don’t like wage cuts, and it is much easier to put the price of labour up than down, even if it might be a good idea. This gives us a rare benefit of inflation, because it cuts the real cost of wages (albeit slowly) while other prices are rising, so labour ends up being cheaper if this is what is needed eg unemployment is high.

- Skills shortages may develop in particular parts of the labour market. For example, two years ago there was a desperate shortage of IT workers due the dot.com boom. Wages for these workers rose sharply, and businesses even started ‘poaching’ each others’ employees with ever-ritzier job offers. This puts up costs. Inevitably other groups of workers got jealous and began to press for rises which put up costs even more. At the same time there were pockets of high unemployment in the country because some workers are geographically immobile (they won’t/can’t move to where the jobs are) or occupationally immobile (they don’t know how to do the new jobs) or both.

6. Efficiency. If costs rise there are two answers. Only one is to raise prices. The other is to become more efficient so unit costs fall and profits are restored. The



more efficient businesses are, the less likely it is they will have to raise prices, and the less likely is inflation.



Chapter 4Inflation and Stock Market

Inflation And Stock Market



Inflation is a state in the economy of a country, when there is a price rise of goods as well as services. To meet the required price rise, individuals have to shell out more than is presumed. With increase in inflation, every sector of the economy is affected. Ranging from unemployment, interest rates, exchange rates, investment, stock markets, there is an aftermath of inflation in every sector. Inflation is bound to impact all sectors, either directly or indirectly. Inflation and stock market have a very close association. If there is inflation, stock markets are the worst affected.

Inflation and stock market- the logistics:

Prices of stocks are determined by the net earnings of a company. It depends on how much profit, the company is likely to make in the long run or the near future. If it is reckoned that a company is likely to do well in the years to come, the stock prices of the company will escalate. On the other hand, if it is observed from trends that the company may not do well in the long run, the stock prices will not be high. In other words, the price of stocks are directly proportional to the performance of the company. In the event when inflation increases, the company earnings (worth) will also subside. This will adversely affect the stock prices and eventually the returns.

Effect of inflation on stock market is also evident from the fact that it increases the rates of interest. If the inflation rate is high, the interest rate is also high. In the wake of both (inflation and interest rates) being high, the creditor will have a tendency to compensate for the rise in interest rates. Therefore, the debtor has to avail of a loan at a higher rate. This plays a significant role in prohibiting funds from being invested in stock markets.

When the government has enough fund to circulate in the market, the cost of goods, services usually go up. This leads to the decrease in the purchasing power of individuals. The value of money also decreases. In a nut shell, for the economy



to flourish, inflation and stock market ought to be more conforming and predictable. High energy prices, rising unit labor costs and pressure on supplies of key resources such as steel and cement (thanks to Hurricanes Katrina and Rita) are lining up like some ill-fated stars to guarantee the Fed will continue raising short-term interest rates. High interest rates and companies raising prices don’t add up to an investment profile most investors enjoy. However, stocks are still a good hedge against inflation because, in theory, a company’s revenue and earnings should grow at the same rate as inflation over the time.

Global MarketWhile some companies can react to inflation by raising their prices, others who compete in a global market may find it difficult to stay competitive with foreign producers who don’t have to raise prices due to inflation.More importantly, inflation robs investors (and everyone else) by raising prices with no corresponding increase in value. You pay more for less.This means company’s financials are over-stated by inflation because the numbers (revenue and earnings) rise with the rate of inflation in addition to any added value generated by the company.

EarningsWhen inflation declines, so do the inflated earnings and revenues. It is a tide that raises and lowers all the boats, but it still makes getting a clear picture of the true value difficult.The Fed’s chief inflation-fighting tool is short-term interest rates. By making money more expensive to borrow, the Fed effectively removes some of the excess capital from the market.Too much money chasing too few goods is one classic definition of inflation. Taking money out of the market slows the cycle of price increases.There are two more meetings of the Open Market Committee (the body that sets rates) in 2005: Nov. 1 and Dec. 13.Given the pressures mentioned earlier, you can take it to the bank that the Fed will keep raising rates at least through the end of the year.

InvestmentsShould you be concerned about inflation and your investments? If you have a substantial portion of your portfolio in fixed income securities, the answer is a



definite yes.Inflation erodes your purchasing power and retirees on fixed incomes suffer when their nest egg buys less each passing year. This is why financial advisers caution even retirees to keep some percentage of their assets in the stock market as a hedge against inflation.The more cash or cash equivalents you hold, the worse inflation will punish you. A $100 under the mattress will only buy $96 worth of goods after a year of 4 percent inflation. Look for inflation-indexed products like the Treasury I Bonds and other products that offer a hedge against rising rates.

Rising Interest Rates

The most common treatment for inflation is for the Fed to raise interest rates. Rising interest rates play havoc with bonds since new bonds pay more interest than older bonds. To compensate for the difference in interest rates, bond prices fall. Rising energy (oil) prices can fuel inflation by making just about everything more expensive to produce and transport. Along with food prices, the price of energy can seem to distort the inflation rate. However, economists also calculate the rate of inflation (Consumer Price Index) without food and energy. When this “core” inflation rate begins moving up, it means that higher prices are spreading throughout the economy.

Impact of Inflation on Conditional Stock Market Volatility

The volatility of security prices has been studied for many years and a number of



stylized facts have been presented in the literature. One of the most prominent

stylized facts is of volatility clustering; that is, large (small) shocks tend to follow

similar large (small) shocks. One reason for this might be that stock market

volatility depends on the overall health of the economy, and real economic

variables which tend to display persistence. Therefore, an interesting question in

finance is: what derives stock market volatility? Understanding the nature of

stock market volatility gives some important implications for policy makers,

economic forecasters and investors.The classic paper in the literature is that by

Schwert (1989), which looked at the relationship between stock market volatility

and the volatility of real and nominal macroeconomic variables. The impact of

the level of economic activity, financial leverage, and stock trading. It is found

that macroeconomic volatility as measured by movements in inflation and real

output have weak predictive power for stock market volatility and returns. In

particular, inflation volatility predicts stock market volatility only for the sub-

period 1953-1987. The results point to a positive link between macroeconomic

volatility and stock market volatility, with the direction of causality being

stronger from the stock market volatility to macro economic variables. Davis and

Kutan (2003) extended Schwerts study by accounting for volatility persistence in

an international setting. Their results are in line with the findings in Schwerts

paper in the sense that the variability of inflation and output growth rate has

weak predictive power for conditional stock market volatility. On the other hand,

existing studies in the literature, for example Engle and Rangel (2005) provide

evidence for the impact of the overall health of the economy on unconditional

stock market volatility. By using Spline Garch model they find that volatility in

macroeconomic factors such as GDP growth, inflation and short term interest

rates are important explanatory variables that increase volatility. They observed

positive relations among long term market volatilities and each of the following



variables: emerging markets, inflation growth, and macroeconomic volatilities.

In particular, they observe that emerging markets including Turkey show larger

expected volatility compared to developed markets including Canada; countries

with high inflation rates experience larger expected volatilities than those with

more stable prices. They compareSpline-GARCH model results with the results

of annual realized volatility as an alternative measure ofunconditional volatility.

Inflation variables are no longer good predictors of annual realized

volatilities .They claim that changes in significance due to the fact that realized

volatility is a noisier measure of unconditional volatility. Other recent research

has examined the information effects on stock market volatility by looking at the

release of news of key macroeconomic variables such as the rate of inflation,

GDP growth, etc.Since the introduction of ARCH and GARCH models by Engle

(1982) and Bollerslev (1986), respectively, there has been an explosion of

research looking for the dynamics of conditional stock market volatility.

Although the standard GARCH (1,1) model captures the stylized fact of stock

return volatility in terms of volatility clustering, it does not capture the

asymmetric effect of information shocks on volatility. Therefore, it is necessary

to search for the appropriate type of GARCH specification to model the

dynamics of stock market volatility. The specification procedure for GARCH

models includes determining time-varying volatility behavior as well as

searching for the asymmetric effects of shocks on volatility.

Inflation: The Real Culprit… and Its Effect on the Stock Market



There have been many times in the past when strong economic performance propelled higher stock prices. The 1920s, the 1950s and the 1980s are classic examples. In the Reagan years, stocks and bonds rallied sharply in response to higher economic growth rates and job creation.

In principle, the stock market should do well under conditions of strong economic growth and low inflation.

If inflation is a growing problem, investment analysts become suspicious of high economic growth or good job reports. Why? Because they fear that it reflects an inflationary boom, an artificial recovery created primarily by “easy credit” by the government, due to high federal deficits and an expanding money supply.

Under inflationary conditions, analysts do not think strong job creation and economic growth are sustainable, and the stock market falls in price because they think that the Fed will need to tighten in the future.

Or if economic growth falls, they think the Fed will ease in the future, and stocks rally. And, as I pointed out in a recent Investment U, all stock prices are forward-looking.

To a large extent, the issue hinges on the relevance of the Fed in the economy, whether the Federal Reserve engages in “easy” or “tight” money.

The impact of price inflation, as measured by the consumer price index. He’s formulated the following trading rule: When CPI inflation is on the rise, stay out of stocks; when CPI inflation is on the decline, buy stocks.

The chart below shows the CPI inflation index since 2000:



Gold and Gold Stock Performance During Deflation and Inflation

The success in trading and investing often requires a counterintuitive approach. The markets often go the opposite way they should. Here are a few examples. Gold was in a bear market for 20 years despite what can be called a credit hyperinflation in the United States. Gold has performed spectacularly this decade in the absence of the kind of price inflation we saw in the 1970s. Treasuries have risen this decade along with Gold, Oil and Commodities. When has that happened in history, Now back to precious metals. The main idea for investing in this sector is to protect your purchasing power or protect against inflation. So it makes sense to buy the sector during an inflationary period. Right? A look at history combined with some common sense analysis reveals that precious metals and the producing companies outperform during deflationary periods and in advance of an inflation cycle.The Great Depression initially was a deflationary event but it concluded in inflation. Using the calculator from inflationdata.com, I calculated the change in prices in the 1930s and 1940s. In the 1930s, prices fell 18%, while they rose 70% in the 1940s. But what happened in the markets.



Below is the chart of the Barrons Gold Mining Index, dating back to 1939. The rectangle shows 1940 to 1950. There was deflation in the 1930s and huge inflation in the 1940s. Yet the gold stocks performed far worse in the 1940s.

The reality is that the precious metals complex outperforms AHEAD of reinflation, while the rest of the commodity sector outperforms DURING the ensuing inflation. Gold stocks perform best when their margins are expanding. That can happen


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when the price of Gold stays flat and cost inputs (oil, steel, labor) fall. It can happen when gold rises and rises faster than cost inputs. When inflation begins to take hold, the precious metals complex has already anticipated it. Inflation raises the cost of everything. As the cost of steel, oil and labor rise, it hurts the profit margins of gold producers. Hence, gold companies outperformed during the deflation and early reinflation of the 1930s, but underperformed during the inflation of the 1940s.In the early 2000s, there was a fear of deflation. As you can see from the chart below, from 2001-2003 gold stocks strongly outperformed gold as well as commodity stocks. Gold bottomed before the rest of the commodity sector and advanced before inflation began to take hold. As inflation began to take hold, the gold stocks underperformed both gold and commodity stocks and even while the price of gold rose from $600 to over $1,000.

The chart of SP 500 Index showing Relative Price Growth :


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It appears the consensus is wrong on both counts. One side says there is no inflation on the horizon, so the precious metals sector isn’t an appropriate investment. The other side says that there will be hyperinflation, so buy gold. Hyperinflation may be good for physical gold but it is deleterious to everything else including society and the political structure. The reality is that the current macroeconomic environment is most advantageous for gold stocks and then gold. However, if and when inflation begins to take root the precious metals complex will under perform and your funds will best be utilized elsewhere.



Chapter 5

Inflation Impact on Different Sectors



Inflation impact on FMCG Sector

Manufacturers of fast moving consumer goods (FMCG) are reeling from high inflation as their input costs have gone up while their sales have stagnated, says a leading industry group.

“With the prices of key raw materials increasing, FMCG companies registered a 16.2 per cent rise in their cost of raw materials in three months ending March," the Associated Chambers of Commerce and Industry of India (Assocham) Eco Pulse (AEP) has stated.

The annual rate of inflation touched a 42-month high of 7.83 per cent for the week ended May 3.

FMCG majors Godrej and Marico registered a decline of 0.88 per cent and 8.28 per cent in their total income on sequential quarter basis, while Hindustan Unilever and Dabur managed to post a 15.72 per cent and 16.47 per cent increase respectively.

“The sector witnessed a decline of 15.38 per cent in their net profits putting pressures on their volume growth, which grew by only 5.76 per cent in Q4 2007-08," Assocham president Venugopal N Dhoot said in a statement.

The big dampener has been rising costs of key inputs wheat and milk, a rise that shows no sign of abatement. Wheat price rose 0.38 per cent in Q3 and 1.13 per cent in Q4 last fiscal. Milk price rose 8.84 per cent in Q3 and 9.13 per cent in Q4. Fuel and power cost rose 0.65 per cent in Q3 and 5.06 per cent in Q4.

Dhoot added: “Despite a 15.7 per cent growth in its total income, Hindustan Unilever reported a decline of 39.41 per cent in its net profit after tax in the fourth quarter as compared to Q3 of 2007-08."

In Q4, Godrej Consumer Products Ltd (GPCL) spent 23.26 per cent more on advertising and sales promotion than it had done in the previous quarter, but registered a decline of 5.11 per cent in its net earnings.



Inflation impact on Telecom Sector

The slow growth in economy, rising inflation and revenue enhancing measures (particularly taxes) by the Government hit the telecom sector growth adversely during the first half of the fiscal year 2008-09. The first half of fiscal year 2008-09 witnessed a slow growth in economy coupled with hyper inflation, acute power shortages, a slowdown in the manufacturing and services sectors, a sharp increase in interest rates and widening current account deficit.

Telecommunication Authority has pointed out this in its quarterly report for October-December 2008. Report said the development indicators of the sector i.e., subscribers, teledensity and revenue continued to show declining trend during Jul-Dec, 2008. Total teledensity was increasing more than 7pc per quarter since July 2007.

However, its rate of growth declined in last quarter of fiscal year 2007-08 where its quarterly growth was registered only 2.2pc during Oct-Dec 2008. Owing to the above factors, it is expected that GDP growth for fiscal years 2008-09 will be around 2.5pc.

The inflation rate as measured by the changes in Consumer Price Index (CPI) stood at 24.4 t per cent during the period Jul-Dec 2008 as against 8.0 per cent in the comparable period last year.

The food inflation is estimated at 31.2 per cent and non-food 19.2 per cent, against 11.6 per cent and 5.4 per cent in the corresponding period of last year. To cope up with the situation adopted tight monetary policy where policy rate was adjusted upward to control on aggregate demand in the economy.

Total teledensity of the country counted 59.6pc at the end of December 2008 which was 59.89pc at the end of Sept 2008. This decline is mainly attributed to cellular mobile sector whose contribution in teledensity is more than 93pc. Though fixed line teledensity continued to decline in last few years however this gap was being filled by cellular mobile sector.

It has been argued that decline in fixed line teledensity would be compensated through Wireless Local Loop (WLL) segment. However, the WLL growth pace is slow which is unable to fill the gap. Telecom regulator is continuously watching these negative trends and making its utmost efforts to provide relief to operators in terms of taxes and other charges to improve the situation.



The stable economy, consistency in policies, stable financial environment and strong economic fundamentals such as low inflation and low fiscal deficit and freedom to investors to repatriate their profits are considered prerequisite to attract foreign investment in any country of the world.

Despite a slow down in economy as well as of telecom sector, Foreign Direct Investment in telecom sector of Pakistan continued in last few years which indicates the confidence of foreign investors in their policies, as during the last 6 months (Jul- Dec, 2008) telecom sector received over $ 716m FDI inflows which becomes 31 pc of total FDI landed in Pakistan during this period.

Impact of Inflation rate hike on Banking sector



The Reserve Bank of India (RBI) this week increased the Cash Reserve Ratio (CRR) by 25 bps to 9% and Repo rate by 50 bps to 9% on July 29, 2008 in its credit policy review in order to tame the surging inflation and keep the rising commodity prices at bay. However, the Reverse Repo rate was left untouched at 6%.

CRR is the minimum amount that banks must keep with the central bank in the form of cash or near cash securities, whereas the repo rate is the rate at which the RBI lends money to other banks. Reverse repo is the rate at which RBI borrows money from other banks.After the action on the rate front by RBI, the BSE Bankex tumbled nearly 8% on July 29, with major banking stocks like SBI, HDFC Bank, ICICI Bank falling 7-8% each. But on the remaining days the Bankex managed to trade in the green as global markets put up a good show backed by easing crude oil prices worldwide. Banking stocks are expected to remain under some amount of pressure in the coming days with the increase in borrowing costs and lack of free cash available. There is enough money in circulation outside the banking system in urban and rural India that must be brought into the banking system by way of current and savings accounts and this is the accurate way to mitigate the burden of high interest rates.These interest rates will not remain high forever and forever.

Following the CRR and Repo rate hike by the RBI, many of the banks have also revised their lending rates upward, the details of which is given in the following table:The impact of the rate hike can be simply put as under:

BPLR (Benchmark Prime Lending Rate)

Bank Current Rate (p.a.) Previous Rate (p.a.)

Axis Bank 15.75% 15.25%

PNB Bank 14% 13%

IDBI Bank 14.25% 13.75%

ICICI Bank 17.25% 16.50%

Bank of Rajasthan (BoR) 16% 15%

Yes Bank 17% 16.50%



The impact of the rate hike can be simply put as under:Suppose a borrower has taken a housing loan on a floating rate of interest (this rate of interest keeps fluctuating with the revision in the lending rates by RBI in its credit policy review). When the central bank raises the key rates like CRR, Repo rate etc as a part of its measures to suck the excess liquidity from the economy, both private and public sector banks follow suit, a move which ultimately puts the extra burden into the pockets of the borrower.With the rate hike, banks borrow money at higher rates from the central bank thereby retail borrowers also have to pay more interest rate, leading to increase in their EMIs for housing loans. This is coupled with a fall in demand from fresh borrowers. Due to the surging inflation, new borrowers tend to meet their ends by satisfying their basic necessities first and postpone their other needs in the rising rate scenario.There is no doubt, that the Banking sector as a whole will bear the brunt of the RBI action and may also be gearing itself up for a further rate hike in the days to come. Banks with high credit growth would be under scanner as RBI has also advised lenders to exercise greater prudence when lending. With the RBI vowing to tame the rising inflation and the interests of the `aam aadmi` foremost on the government`s mind as the countdown to the election begins, growth would take a backseat as of now. Sectors like Realty and Auto are also expected to take a hit as are sectors like Retail which would be the prime casualties, being the offshoots of rising income levels among consumers and depend directly or indirectly on consumer spending and economic prosperity



Chapter 6 Review of Literature



Literature Review

Barro (1996) “Inflation and Economic Growth,” by Robert Barro. Federal Reserve Bank of St. Louis Review, Vol. 78, pp. 153-169.

Bruno and Easterly (1998) “Inflation Crises and Long-Run Growth,” by Michael Bruno and William Easterly. Journal of Monetary Economics. Vol. 41, pp. 3-26. See also: Bruno, M. and Easterly, W. “Inflation and Growth: In Search of a Stable Relationship,” Review of Federal Reserve Bank of St. Louis. Vol. 78, no. 3. May/June 1996. pp. 139-46.

Bruno (1995) “Does Inflation Really Lower Growth?” by Michael Bruno. Finance & Development. Vol. 32, no. 3. September 1995. pp. 35-38. Cites a then-recent major World Bank study of the link between inflation and economic growth in 127 countries from 1960 to 1992 found that inflation rates below 20% had no obvious negative impacts for long-term economic growth rates.

Burdekin, et al (2000) “When Does Inflation Hurt Economic Growth? Different Nonlinearities for Different Economies,” by Richard C.K. Burdekin, Arthur T. Denzau, Manfred W. Keil, Thitithep Sitthiyot, and Thomas D. Willettt. Claremont Colleges Working Paper in Economics.

Fischer (1993) “The Role of Macroeconomic Factors in Growth,” by Stanley Fischer. Journal of Monetary Economics. Vol. 32, pp. 45-66.

Ghosh and Phillips (1998) “Warning: Inflation May be Harmful to Your Growth,” by Atish Ghosh and Stephen Phillips. IMF Staff Papers. Vol. 45, pp. 672-710.

Khan and Senhadji (2001) “Threshold effects in the Relation Between Inflation and Growth,” by Mohsin S Khan and Abdelhak S. Senhadji. IMF Staff Papers. Vol. 48, pp. 1-21.



Chapter 7Research Methodology



Research methodology

The word research derives from the French recherché, from recherché, to search closely where "chercher" means "to search"; its literal meaning is 'to investigate thoroughly'. Research is the process of investigating, discovering and revising the human knowledge. It leads to the betterment of human knowledge about different aspects of the world. It could also be explained as collection of information and data and then studying, analyzing that data so as to improve the existing amount of knowledge on that subject, whatever it may be.

There are two major approaches to research: qualitative and quantitative approach. For qualitative research, the researcher has to have a proper understanding of the human behavior. The researcher needs to understand the mental state of a human in different situations and how would it react to them. In other words, we can say that it simply investigates why and how of decision making. It emphasizes upon person’s likes or dislikes, or on someone’s choice to approve or disapprove etc.

However, quantitative research focuses towards developing and employing mathematical models, theories and hypothesis etc. The process of measurement is central to quantitative research because it provides the fundamental connection between empirical observation and mathematical expression, of quantitative relationships. It emphasizes upon ideas, concepts and the project-ability of the results. Since, in this research we use a hypothesis and other empirical data to support our work; so we will use quantitative method of research.

The Study The present investigation is a comparative study of ERP implementation in the Indian SME’s. The comparison was done between the ERP implemented in the public sector and the private sector, and to complete the study, the data needed was collected using the survey method.

Research approachBy using Survey in different companies and meeting by using personal contacts.

Sampling Design

1 Sampling Population: - Population was the higher authorities of the private sector and the public sectors enterprises.



2 Sampling Frame: - The data were collected through personal contacts as well as meeting the authorities directly; the frame was the people who are working in the Indian sector, either public or private.

3 Sampling Element: - The sampling elements were individual respondents.

4 Sampling Technique: - Purposive/Convenient sampling technique was used. 5 Sampling Size: - Overall, there were 17 respondents out of which 11 were the officials of the private sector enterprises and rest of them are from Public sector enterprises.

Tools used for Data Collection Questionnaires were designed and were administered for the purpose of finding the views of public on the Inflation impact . The data was collected on a Likert type of scale, where option 1 was for 4 points, 2 was for 3 points, 3 was for 2 points and 4 was for 1 point. A computer search of databases of the published literature area was carried out to find previous research in the study of Inflation. This was based on the searching of results on factors affecting its implementation.

Statistical methods employed for Data Analysis The following methods were used for the purpose of analyzing the data:

1. Reliability Test: - The reliability test was required to check the reliability of the questionnaire designed.

Reliability analysis allows you to study the properties of measurement scales and the items that compose the scales. A reliable questionnaire is one that would give the same results if you used it repeatedly with the same group. The Reliability Analysis procedure calculates a number of commonly used measures of scale reliability and also provides information about the relationships between individual items in the scale. Intra-class correlation coefficients can be used to compute inter-rater reliability estimates. For example, does my questionnaire measure customer satisfaction in a useful way? Using reliability analysis, it can be determined that whether the extent to which the items in your questionnaire are related to each other, an overall index of the repeatability or internal consistency of the scale as a whole can be collected, and problem items that should be excluded from the scale can be identified.



2- Analysis of the correlation between the various factors of the same types of company’s separately for which were used to design the questionnaire. For this purpose, we used the method of Karl Pearson’s method of correlation. Correlation coefficient is the term used to indicate the strength and direction of a linear relationship in case of two random variables.

3- T-test to compare the means of the two unequal sized samples.

This equation is only used when the two sample sizes are unequal. It is assumed that the two distributions have the same variance. The t statistic to test whether the means are different can be calculated as follows:

Where s2 is the unbiased estimator of the variance, n = number of participants, 1 = group one, 2 = group two. n − 1 is the number of degrees of freedom for either group, and the total sample size minus 2 is the total number of degrees of freedom. The statistical significance level associated with the t value calculated in this way is the probability that, under the null hypothesis of equal means, the absolute value of t could be that large or larger just by chance—in other words, it's a two-tailed test, testing whether the means are different where either one or the other might be the larger one if they are different.

4- Correlation

Correlation coefficient

Where



N is the total no. of items

ai, bi is the respective value in that records

Sigma A and B are Standard Deviation

Correlation can be negative, positive and Zero it depend on the sign of covariance since SD are always Positive but the correlation coefficient have range from -1.0 to +1.



Chapter 8Data Analysis



Q- 1. Which sector will be hit the hardest by the current crisis ?

FMCG

Real Estate

IT

Banking & Insurance Sector

Pie chart for the above question is:

Q-2. What is the best lesson learnt from sub prime crisis by an emerging economy ?

Sound banking practices

Controlled Derivatives market

Limited investment by Indian companies abroad

FDI should be given more priority than FII



% of R es pons e from public

40%

20%

30%

10%

O ption 1

O ption 2

O ption 3

O ption 4


23%

27%

40%

10%

O ption 1

O ption 2

O ption 3

O ption 4


Q- 3. What is the best way to combat economic slowdown ?

Retrenchment

Reduction in the salary

Training & Redeployment

Moratorium on recruitments


Q- 4. What is the biggest impact of financial crisis on India ?

Stock Market crash

Inflation

Decrease in the forex remittances

Higher interest rates




30%

25%

25%

20%O ption 1

O ption 2

O ption 3

O ption 4

% of R es pons e from public18%

25%

42%

15%O ption 1

O ption 2

O ption 3

O ption 4


Q- 5. Which emerging economy will be the least affected by the recent financial crisis ?

China

Brazil

Russia

India


Q- 6. What will be India’s GDP in the year 2009-10 ?

Below 5%

5-6%

6-7%

7% & above




18%

22%

48%

O ption 1

O ption 2

O ption 3

O ption 4


24%

16%

46%

O ption 1

O ption 2

O ption 3

O ption 4


References

References



1. www.investopedia.com

2. www.sciencedirect.com

3. www.wikipedia.com

4. www.investorwords.com

5. www.emeraldinsight.com


http://www.emeraldinsight.com/

http://www.investorwords.com/

http://www.wikipedia.com/

http://www.sciencedirect.com/

http://www.investopedia.com/


Questionnaire



Questionnaire

GENERAL INFORMATION

Name:

Email address:

Cont. No.:-

Occupation:

Gender:

Age:

* (This survey is being conducted by management student and is only for educational

purpose. We kindly request for your co-operation)

Please Tick (√) any one of the given options :

Points(Option1=4points, Option2=3points, Option3=2points, Option4=1point)

Q- 1. In your view, what caused the current financial crisis? Was it:

Wrong decisions by U.S banks regarding giving loans for housing purpose

Incompetent executives

Flawed economic system

Excessive Greed

*Q- 2. How long will the recession last ?

6 months

6 months - 1 Year

1-2 year

2 year & above



Q- 3. What will be India’s GDP in the year 2009-10 ?

Below 5%

5-6%

6-7%

7% & above

Q- 4. Which sector will be hit the hardest by the current crisis ?

FMCG

Real Estate

IT

Banking & Insurance Sector

Q- 5. Which emerging economy will be the least affected by the recent financial crisis ?

China

Brazil

Russia

India

Q- 6. Which industry segment is worst affected by the current crisis ?

Retail sector

BPO / Outsourced sourcing

Airlines & tourism

Financial Intermediaries

Q- 7. What is the best way to combat economic slowdown ?

Retrenchment

Reduction in the salary

Training & Redeployment

Moratorium on recruitments

Q- 8. What is the best lesson learnt from subprime crisis by an emerging economy ?



Sound banking practices

Controlled Derivatives market

Limited investment by Indian companies abroad

FDI should be given more priority than FII

Q- 9. What is the much talked about great depression ?

The period in which President Roosevelt was assassinated

When the stock market crashed causing unemployment and homelessness

When the Y2k bug hit

When economy suffered due to tsunami

Q- 10. What is the biggest impact of financial crisis on India ?

Stock Market crash

Inflation

Decrease in the forex remittances

Higher interest rates

Thank you for your Participation and Co-operation in completing this questionnaire. Your time and effort are sincerely APPRECIATED.


Vimarsh Kapoor

MBA Final Year

ABV-IIITM Gwalior

[email protected]

mailto:[email protected]

Documents

Inflation and Its Impact on Stock Market and Company_s Economic Growth