Inflation in India

Investor’s Query: The average Inflation, Consumer Price Index (CPI) in India from 1958 – 2015 comes up to 7.46% per annum. The attached file contains the year on year inflation rates in India and the calculated average over the years. Hence, how much is the average inflation to be considered in India?

Mr. Gerard Colaco: The average CPI inflation rate in India from the government sources may very well be 7.46% from 1958 to 2015.  My only problem is that this figure is useless. The index covers between 200 & 300 items.  Formerly, the number of items was even less. Contrast this with the US CPI which first creates elementary indices to show the prices of similar goods in the same area. There are 8,018 such elementary indices, from which the CPI is ultimately derived, the US CPI being nothing but an aggregate of all these 8,018 basic indices.

I do not exactly remember the total number of goods and services tracked by these indices in the US, but remember reading that this number could exceed 50,000! So, if I were in the US, I would treat the CPI figures as very credible. Not so in India, where in the past politics has resulted in faulty CPI figures being published. Over the last perhaps two and a half decades however, the RBI has made laudable efforts to have better, more accurate and therefore more credible indices in India.  In particular, Dr. Raghuram Rajan has spearheaded the move towards better, cleaner and more accurate data.

Since Indian politicians have always had a vested interest in understating inflation, I refuse to accept the average CPI inflation put out by the government at face value. What then is the real inflation in India? We know that in the very long run, say 50 years or more, the average return on gold is a good proxy for the average CPI inflation. But we have to take into consideration that the returns on gold in India are higher than in other countries because of the craze for gold in India.

The return on gold in this country over the last 50 or 60 years has been approximately 9.5% compounded. I would be prepared to stick out my neck and conclude that the actual CPI inflation in India will lie somewhere between these figures of 7.46% and 9.5%, say 8.5%.  There is nothing wrong in assuming a slightly higher inflation rate, given the vagaries of Indian politics as well as Indian economics.

Of course, this is fine if one want to continue with inflation calculations in their financial plans. I have never done this, nor will I do it in future. For me, such assumptions, calculations and projections are a work of fiction. I prefer to deal with fact.  The most effective measure that I have found in my 30-year career to good investors into putting by something for a rainy day is the simple savings ratio.

In the Indian context, anyone who saves less than 25% of net income fails the savings test. Anyone who succeeds in saving 50% of net income tops the class. Most prudent and serious investors would end with a savings ratio in the 30% to 35% range, especially when there is a family with growing children, even if there is a double income. This savings ratio of 30 to 35% that most middle class investors achieve, is certainly good.

I have found far better value in people who focused on the savings ratio to invest correctly and persistently. I have numerous examples of clients who achieved financial freedom this way. I have not come across a single individual who achieved financial freedom by obsessing about the accuracy of CPI inflation rates and embarking upon complex future mathematical calculations.

Inflation in India since 1958.