Inflation is a powerful and often unnoticed force that impacts our everyday lives. It is the gradual rise in the prices of goods and services over time, eroding the purchasing power of our money. While a mild level of inflation is normal and even necessary for economic growth, it can also have significant consequences if it spirals out of control.
In this blog, we’ll dive deep into the concept of inflation, its causes, how it is measured, and the different ways it can affect everything from interest rates to investments. We'll also explore how inflation is linked to currencies and why it can vary across countries. By the end of this read, you'll have a clear understanding of inflation’s impact on the economy, and how you can protect yourself against its potential consequences.
What is Inflation
Inflation is a measure of the change in purchasing power in a given currency over time. Implicit in this definition are two key components of inflation.
First is the purhasing power, start with a defination of what you are purchasing and this detail, as we will see, can lead to differences in inflation measured over a given period, across measures/services.
Inflation is tied to currencies. Different currencies can be exposed to different levels of Inflation. With the level of inflation, we can understand why interest rates can vary across different currencies.
To simplify, a Decrease in the purchasing power over time leads to inflation and an increase in the purchasing power within a country can lead to deflation. If there is inflation in a currency, and the loss of purchasing power over a period is acute, you have hyper inflation. Countries with hyper inlfation are countries like Venezuela with 225%, Burundi with 123% by the end of 2025 and many more you can look into this in detailed report by PWC.
How do you measure Inflation?
Inflation is the change in purchasing power in a currency, over time, how do you measure inflation? Most inflation indices start by defining a bundle of goods and services to use in measuring inflation and a process for collecting the price levels of those goods and services, to come up with a measure of inflation using CPI and WPI. Let's try to understand CPI and WPI.
1) What is CPI?
The Consumer Price Index measures changes in the average price level of goods and services purchased by households over time. It is used to measure inflation and indicates the cost of living for consumers. CPI is calculated by selecting a basket of goods and services that represent typical consumer purchases and tracking the changes in their prices over time. The index is often used to adjust wages, pensions, and government benefits to account for changes in purchasing power
2) What is WPI?
The Wholesale Price Index measures changes in the average price level of goods traded in bulk or at the wholesale level. It is primarily used as an indicator of inflation in the production and distribution stages of the economy. WPI tracks the price changes of goods before they reach the retail level and includes commodities such as raw materials, intermediate goods, and finished goods. It is often used by policymakers, businesses, and analysts to monitor inflationary pressures within the economy and make decisions based on the price trends
India's Current Inflation Rate 2025
According to the data released by the Ministry of Statistics and Programme Implementation, India's consumer price index inflation is 2.82 percent (Year-on-Year) in May 2025. The corresponding inflation rates for rural and urban areas are 2.59 percent and 3.07 percent, respectively. MOSPI attributed the decline in headline inflation and food inflation during May 2025 to the decrease in inflation of Pulses and products, Vegetables, Fruits, Cereals and products, Households goods and services, Sugar and confectionery and Egg and the favourable base effect.
The Y-o-Y inflation rate based on the All India Consumer Food Price Index (CFPI) is at 0.99 percent for May 2025. The corresponding inflation rates for rural and urban areas are 0.95 percent and 0.96 percent, respectively. Data
India Inflation Rate (CPI) - Historical Data
Year | Average Inflation Rate | Annual Change |
|---|---|---|
2025 | 2.82 (May) | -0.34% |
2025 | 3.34 (March) | -0.27% |
2024 | 5.22 (December) | +0.13% |
2024 | 5.09 (February) | -0.4% |
2023 | 5.49 | -1.21% |
2022 | 6.7% | 1.57% |
2021 | 5.13% | -1.49% |
2020 | 6.62% | 2.89% |
2019 | 3.73% | -0.21% |
2018 | 3.94% | 0.61% |
2017 | 3.33% | -1.62% |
2016 | 4.95% | 0.04% |
2015 | 4.91% | -1.76% |
2014 | 6.67% | -3.35% |
2013 | 10.02% | 0.54% |
India Inflation Rate (WPI) - Last One Year Data
Month (FY24) | Wholesale Purchase Index Rate |
|---|---|
Septemeber 2024 | 1.84% |
August 2024 | 1.31% |
July 2024 | 2.04% |
June 2024 | 3.43% |
May 2024 | 1.26% |
April 2024 | 0.53% |
March 2024 | 0.20% |
February 2024 | 0.27% |
January 2024 | 0.73% |
December 2023 | 0.26% |
November 2023 | -0.52% |
October 2023 | -0.26% |
September 2023 | -0.52% |
August 2023 | -1.36% |
July 2023 | -4.12% |
June 2023 | -3.48% |
May 2023 | -0.92% |
April 2023 | 1.34% |
Using Interest Rates to Understand Inflation
To understand the link between expected inflation and interest rates, consider the Fisher equation,
(1+Nomial Rate) = (1+ real interest rate)*(1+inflation rate)
Here inflation is the expected inflation and the expected real interest rate. Put simply, if you expect the annual inflation rate to be 2% in the future, you would need to set the interest rate on a bond above 2% to earn a real return. Expected inflation can be calculated by subtracting nominal risk free rate and real interest rate.
There is one final way to link actual to expected inflation. In any period, the actual inflation rate can be higher or lower than what was expected during that period. That difference is unexpected inflation, a positive number when inflation is greater than expected, and negative when it is lower than expected.
Unexpected inflation in period t = Actual inflation in period t - Expected inflation in period t
Currency and Inflation
Inflation is mostly country-specific. Inflation can be controlled monetarily through central banks (like RBI in India). Thus, even in this new technology-driven global economy, there remain some currencies where inflation rates are high, and others where inflation rates are not just low, but negative (deflation). Drawing on my earlier point that interest rates convey inflation expectations, I would argue that the biggest, though not the only, reason for differences in riskless rates across currencies is differences in expected inflation. Drawing on my earlier point that interest rates convey inflation expectations, I would argue that the biggest, though not the only, reason for differences in riskless rates across currencies is differences in expected inflation
High-inflation currencies will loose value relative to low-inflation currencies in the long term
How Inflation Affects Fixed Income and Equities
Fixed Income
To understand how inflation affects the value of a fixed income bond, let's start with the recognition that in a fixed income security, the buyer has a contractual claim to a pre-specified cash flow and that cash flow is in nominal terms. Thus, expected inflation and unexpected inflation affect bond buyers in very different ways:
Expected Inflation: The coupon rate (cash-flows) from the bond is initiated at the start of the contract which incorporates the expected inflation into the mix. Thus if expected inflation is 5%, a rational bond buyer will demand a much higher interest rate than when expected inflation is 3%.
Unexected Inflation: As mentioned before, expected inflation is the difference between the actual and expected inflation. I the actual inflation is higher (lower) than the expected Inflation then the price of the bond will decrease (increase)
With corporate bonds, inflation will have the same direct consequences as they would on default-free or treasury bonds, with an added factor at play. As inflation comes in above expectation, corporate borrowing rates will go up, and those higher interest rates can increase the risk of default across all corporate borrowers. This higher risk may manifest itself as higher default spreads for bonds, pushing down corporate bond prices.
Equities
To understand how inflation affects equity value I look at the drivers of value for a business:
Interest Rates: If inflation is higher than expected, you can expect interest rates to rise, pushing up the returns that both equity investors and lenders demand.
Risk Premiums and Failure Risk: Inflation has no direct effect on equity risk premiums, but it remains true that higher levels of inflation are associated with more uncertainty about future inflation. The effect of higher-than-expected inflation on default spreads is more intuitive and reflects the reality that interest expenses will be higher when inflation rises, and interest rates go up, and those larger interest expenses may create a higher risk of default.
Revenue Growth Rates: You can see when inflation increases the cost of the items will increase, which inturn makes the prices of the end products go high. This can cause problems for some industries which sells discretionary products.
Operating Margins: If revenues and costs both rise at the inflation rate, margins should be unaffected by changes in inflation, but it is a rare company where this is true.
Inflation Hedge
The only two asset classes that provide a hedge against the inflation are gold and real estate, both from expected and unexpected inflation. While real estate has been a better hedge against expected inflation, gold has done much better at protecting against unexpected inflation. worst affected by inflation are treasury and corporate bonds,
Conclusion
For those who are quick to dismiss inflation, it is worth remembering that it is insidious and sneaky, benign when it is under control, but a destructive force, when it is not, a genie that should be kept in the bottle.
