Monday, July 21, 2008

Inflation - Why are we worried?

One of my colleagues was asking me the other day on what is the surest indication of inflation happening around us? With all this talk of 11% and 12% inflation, where can I see it? A common colleague of ours replied, “Don’t you see prices going up?”. “Yeah, I do, but any more obvious signs?”. I said, “Remove all the coins from your pocket and count the number of 1 rupee, 2 rupee and 5 rupee coins you have”. He had 2 one rupee coins, 6 two rupee coins and 4 five rupee coins. “Well, remember the time when you had more of 1 rupee coins and less of the other two?”. “Man, you are right buddy”. “That’s inflation happening right in your pocket, my dear”, I concluded.

Following that the conversation turned to how inflation might be eating into IT margins. Employees feel the pinch on their pocket and ask for hefty raises. With a 12% inflation, a 15% salary hike is a insult because you are effectively getting a 3% hike in very rough terms. Customers squeeze margins because they try to make up for what they have lost to inflation. Multi year contracts are up for re-negotiations much earlier than anticipated. Quarterly results turn topsy turvy because companies that predicted rosy results by resting on the assured cash flow from multi year contracts suddenly find the tap drying. Inflation has a dampening effect on the stock market. Foreign Direct Investments(FDIs) are being retracted. Exclusive offshore development centers (captive centers) which bloomed in part as result of FDIs are no longer an attractive proposition to MNCs outside India. So all this brings the 8-10% GDP growth to a grinding slowdown. A low GDP growth means low spending power among the working class. A slow GDP growth results in bringing down inflation as the demand from people for goods goes down. So the whole cycle is self adjusting. Why then are we worried? We are worried because nobody wants to be part of the slowdown having enjoyed the fruits of an economic flurry. No generation wants their golden years in life spent in waiting for the economy to take off again. Isn’t it natural human psychology?

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