Inflation kam ?? Wto and india ?? Monetary and fiscal policy ?/ India china ?? what role fdis ???

Dis unvestment privatisation ???

Effects On Time Value Of Money

Price Inflation greatly effects time value of money (TVM). It is a major component of interest rates which are at the heart of all TVM calculations. Actual or anticipated changes in the inflation rate cause corresponding changes in interest rates. Lenders know that inflation will erode the value of their money over the term of the loan so they increase the interest rate to compensate for that loss. Figure 2 showed that inflation has been nearly continuous in the U.S. since shortly after World War II. As you can see, long-term loans made at the real rate of interest without an inflation premium would have actually produced negative returns due to the declining purchasing power of the dollar.

An estimate of the inflation premium contained in interest rates can be seen by comparing two risk-free securities with the same maturity date, one with a fixed rate and the other with a rate indexed for inflation. The Fed strongly influences short term interest rates with their monetary policy. However, longer term rates are set by the market and reflect an inflation rate which is its current best guess. Although it may not be a perfect indicator, the yield of a 10 year, fixed-rate U.S.Treasury note when compared with the rate of a Treasury Inflation Protected Security (TIPS) of the same maturity at least shows that some amount of inflation premium certainly does exist. For example, the Fed Funds rate was recently at 1% and the year-to-year percent change in the CPI (current inflation rate) was 2.3%. At the same time, the anual yield of the fixed-rate note was 4.75% while the TIPS note was at 2%. This would indicate that the market currently expects an average annual inflation rate of around 2.75% (4.75% - 2%) over the ten year period and have added that inflation premium to the fixed-rate, non inflation protected note.

What is Deflation?
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In common usage deflation is generally considered to be "falling prices". But there is much more to it than that. Often people confuse deflation with disinflation or with Depression (as in "the Great Depression"). These three terms are related but not synonymous. According to Investorwords.com the definition of Deflation is "a decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in

government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. The opposite of inflation."

What Causes Deflation?

Although everything said above is true it doesn't present the true nature of deflation. It tries to define it by presenting several possible causes. For a true understanding of both Inflation and Deflation we need to understand Supply and Demand. Just like every other commodity there is a supply of and a demand for "Money". In this article I am not going to address the issues of what true money is, for the sake of this article we will assume money is simply something other people are willing to accept in exchange for goods or services. Price levels are the direct result of the relationship between the supply and the demand for any given item. But the value of the money used to pay for those items is also subject to the same relationship. For the sake of simplicity let's assume that we are on an island and there are ten equally desirable goods in our universe and ten $1.00 bills available to purchase them with. We can safely assume that each item will end up costing $1.00 each. If the quantity of money increases to $20 (without increasing the quantity of goods) the price of the goods will increase to $2.00 - that is inflation. If, however, the quantity of money decreases to $5.00 the price will fall to 50 (deflation). This is what the first part of the above definition is referring to. The money supply can also be reduced if someone on our island hoards half of it and refuses to spend it on anything no matter what. This is the second part of the definition (reduction in spending). So far we have only looked at part of the equation, the supply of money. But what happens if the quantity of goods available increases? What if instead of having ten items we build ten more? We now have twenty items and only $10. 00 so once again each item is worth 50. This form of deflation is the good type. Everyone assumes that deflation is bad because the last major deflation that we had was during the "Great Depression" so deflation and Depression are synonymous in many peoples minds. In actuality if prices go down because the goods can be manufactured more cheaply this ends up increasing everyone's wealth. This is exactly what happened in the late 1990s , with cheap productivity available from former Communist countries the quantity of goods is increased while the money supply increased at a slower rate.

What about Demand?

What about the demand for goods? If everyone on our island already has one of the items available and no one needs any more, naturally the price will also fall as sellers try to find someone to take them off their hands.

So far we have dealt with the supply of money, the supply of goods and the demand for goods, but what about the demand for money? Is it possible that the demand for money could increase or decrease? Generally, the demand for money is measured by how much people are willing to pay to borrow it (i.e. interest rates). If inflation is high, interest rates will have to be higher to compensate for the loss of purchasing power. But also if the demand for money rises banks can charge more to loan it. Conversely, if the demand for money falls interest rates will also fall. So there are four causes for Deflation.
1. 2. 3. 4. Decreasing Money Supply Increasing Supply of Goods Decreasing Demand for Goods Increasing Demand for Money

Note: Increasing demand or decreasing supply of money have the same result i.e. "tight money" either way people want more money than is available. Both could also result in (or cause) higher interest rates. But the higher interest rates should also tend to balance (or decrease the demand for money because it is now more expensive). In other words as interest rates rise at some point the demand drops off because people don't want it bad enough to pay such high rates.

Is Deflation Good or Bad?

Actually, deflation itself is neither good nor bad. It depends on the cause of the deflation whether people will suffer or rejoice. As I said, if the cause is increasing supply of goods that would be good. Another example of this is in the late 1800's as the industrial revolution dramatically increased productivity. However, if deflation is caused by a decreasing supply of money as in the great depression, that would be bad. The stock market crash sucked all the liquidity out of the market place, the economy contracted, people lost their jobs and then banks stopped loaning money because people were defaulting. The problem compounded as more people lost their jobs and money supply fell further causing more people to lose their jobs, etc. etc. Note: During the Depression demand for money was high (but no one could afford it) because supply was low. So deflation can be caused by several different things and thus can be good or bad depending on the cause. For more information see: The Primary Precondition of Deflation --What must happen for Deflation to take over.

What is Inflation?

What is Disinflation Inflation Cause and Effects

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For More Information

Can we have Inflation and Deflation? Is a Stock Market Crash Inflationary or Deflationary? 10 Things You Should and Shouldn't Do in a Deflation 6 Questions You Should Be Asking About the Financial Crisis (And 6 Must-Read Answers) Can the Government Really Stop Deflation? Deflation hits the Movies Deflation Micro vs. Macro Three Myths of Deflation and Recession Deflation? or Hyperinflation? Deflation or Inflation Debate

How would deflation affect investment and consumption? I have trouble wrapping my head around the concept that inflated dollars are worth more and deflated dollars are worth less, for some reason. A. It is the other way around, according to orthodox monetary economics: inflated dollars are worth less and deflated dollars are worth more. Deflation means that the prices of goods and services are going down and so the purchasing power of your dollars is going up. Traditional economics claims that deflation actually increases the value of cash to its holder by enhancing its purchasing power in an environment of declining prices (negative growth in the average price level). Consumers are thus incentivized to delay their consumption. If prices are going down, why not wait and purchase the same for less later on? In my view, though, this is only true in the short-term. It is true that in a deflationary cycle, consumers are likely to delay consumption in order to enjoy lower prices later. But this paralysis in consumption is precisely what renders most asset classes including cash precarious and unprofitable in the long-term. On the policy level, deflationary expectations (let alone actual deflation) lead to liquidity traps: zero interest-rates fail to stimulate the economy and the monetary authorities unable to reduce interest rates further - remain powerless with their ammunition depleted. This means that cash balances and fixed-term deposits in banks yield no interest. But, even zero interest translates into a positive yield in conditions of deflation. Theoretically, this fact should be enough to drive most people to hold cash. Yet, what economists tend to overlook is transaction costs: banks charge account fees that outweigh the benefits of possessing cash even when prices are decreasing. Only in extreme deflation is cash with zero interest a profitable proposition when we take transaction costs (bank fees and charges) into account. But extreme deflation usually results in the collapse of the banking system as deleveraging and defaults set in. Cash balances and deposits evaporate together with the financial institutions that offer them. Moreover: deflation results in gross imbalances in the economy: delayed consumption and capital investment and an increasing debt burden (in real, deflation-adjusted

terms) adversely affect manufacturing, services, and employment. Government finances worsen as unemployment rises and business bankruptcies soar. Sovereign debt (government bonds) another form of highly-liquid, safe investment is thus rendered more default-prone in times of deflation. Like inflation, deflation is a breakdown in the consensus over prices and their signals. As these are embodied in the currency and in other forms of debt, a prudent investor would stay away from them during periods of economic uncertainty. At the end, and contrary to the dicta of current economic orthodoxy, both deflation and inflation erode purchasing power. Thus, all asset classes suffer: equity, bonds, metals, currencies, even real-estate. The sole exception is agricultural land. Food is the preferred means of exchange in barter economies which are the tragic outcomes of the breakdown in the invisible hand of the market. Q. What can consumers do to protect themselves from deflation and inflation, on an investment level as well as in the broader economy? A. Inflation increases the state's revenues while eroding the real value of its debts, obligations, and expenditures denominated in local currency. Inflation acts as a tax and is fiscally corrective, but without the recessionary and deflationary effects of a "real" tax. Thus, inflation is bad for government bonds and deflation increases their value (lowers their yields). Inflation-linked bonds, though, are a great investment at all times, even with minimal deflation. Inflation also improves the lot of corporate - and individual - borrowers by increasing their earnings and marginally eroding the value of their debts (and savings). It constitutes a disincentive to save and an incentive to borrow, to consume, and, alas, to speculate. "The Economist" called it "a splendid way to transfer wealth from savers to borrowers." So, inflation is good for equity markets in the short to medium term, while deflation has exactly the opposite effect. The connection between inflation and asset bubbles is unclear. On the one hand, some of the greatest fizz in history occurred during periods of disinflation. One is reminded of the global boom in technology shares and real estate in the 1990's. On the other hand, soaring inflation forces people to resort to hedges such as gold and realty, inflating their prices in the process. Inflation - coupled with low or negative interest rates - also tends to exacerbate perilous imbalances by encouraging excess borrowing, for instance.
Deflation is kind to cash and cash-equivalents (e.g., fixed-term deposits and CDs), but only in the short-term. In the long-term it has an adverse effect on all asset classes (see what happened in Japan in the 1990s) with the exception of agricultural land. Advertisement 0 0 See all footage | View Slideshow Continue reading at NowPublic.com: Deflation in the USA and its Effects on Consumption and Investmen | NowPublic News Coverage http://www.nowpublic.com/tech-biz/deflationusa-and-its-effects-consumption-and-investmen#ixzz1aHwC6dMW

One of the strongest arguments for investing in stocks is that they provide protection against inflation. Market observers have often said that Federal Reserve chairman Paul Volckers

successful fight against US inflation in the late 1970s and early 1980s laid the groundwork for the huge bull run in the US stock markets in the 1990s. Is there a similar correlation between inflation and the Indian stock market? Well, inflation based on wholesale price index (WPI) was at a very low 1.8% in March 2002, but that had no appreciable impact on the marketthe Sensex was at 3,469 points at that time, marginally lower than in March 2001. Or, consider 1995-96, when the inflation rate had fallen to 4.5% by March 1996, after being as high as 16.9% a year earlier. Yet, between March 1995 and March 1996, the Sensex moved up just a tad, from 3,260 to 3,366. Now consider periods of high inflation. In March 1995, WPI inflation was at 16.9%, rising from 10.6% in the same month the previous year. The Sensex fell from 3,778 to 3,260 over the period. But between March 1993 and March 1994, the Sensex rallied 65%, although inflation increased from 7.1% to 10.6%. The data seem to show that the Sensex has little correlation with WPI inflation. Does the kind of inflation make a difference? The argument that stocks are an inflation hedge is based on the premise that companies are able to raise prices during inflationary times, protecting their earnings. On the other hand, if input prices rise more than that for manufactured goods, then margins will be squeezed. Well, fuel price inflation was at 10.4% in March 2005, but that had no appreciable impact on the bull run then under way. And back in 1993-94, in spite of big increases in inflation for primary articles and for fuel, the stock market rallied. Clearly, there are more powerful factors than inflation that affect stock prices. Could it be growth? Not reallygross domestic product (GDP) growth was 7.3% in 1995-96 and 8% in 1996-97, yet the Sensex went up all of 3% between March 1995 and March 1997. Yet, when GDP growth fell to 4.3% in 1997-98, the Sensex went up in that year. Could it be interest rates? The 10-year yield on the benchmark government bond fell from 10.86% in March 2000 to 6.19% in March 2003, but the Sensex too fell during the period. On the other hand, the 10-year yield went up from 5.15% in March 2004 to 7.93% in March 2007, yet that was the period that saw a huge rally in the Sensex. However, its likely that the huge fall in interest rates from the late-1990s prepared the base for the big rally in stocks years later. And as we can see today, the lagged effect of rising interest rates did impact earnings in the interest-rate sensitive sectors, which affected stocks in those sectors. In a recent note by Citi Investment Researchs global equity strategists, they looked at the relation between inflation and stock returns in global markets and concluded that investors need three things to occur for equities to provide strong returns. First, inflation needs to be in the not-too-high, not-too-low range. Second, inflation should be falling. Third, valuations should be reasonable. That last bit about valuations perhaps makes all the difference.

And as far as the Indian market is concerned, that valuation has usually depended on foreign fund inflows. Liquidity, rather than domestic fundamentals,has been the main determinant of returns in the Indian market. Emamis current growth reflects its hunger Emami Ltd has grown its net profit by as much as 46.6% on a compounded annual average basis in the past three years, riding piggyback on a smart 38.7% average annual growth in sales. The companys acquisition of a large stake in Zandu Pharmaceutical Works Ltd at a premium valuation shows that it wants the growth momentum to continue. One analyst says it reflects Emamis hunger for growth. The company has bought out one of Zandus promoters at Rs6,900 per share, which works out to a valuation of over 30 times expected earnings for the year till end-March 2008 (Zandu is yet to report the results). Emami itself trades at about 20 times trailing earnings, which signifies that its paying a high premium for gaining control of Zandu. It has offered minority investors a slightly higher price (Rs7,315 a share). But another promoter group, which manages the company, is likely to stay put and the acquisition may not be smooth. Even if Emami gets control, itll be after paying a substantial premium. All this makes the acquisition look expensive. Not only is the price-earnings multiple much higher than peers, but even Zandus growth rate has been rather sedate at 4% for the first nine months of financial year 2007-08. But, since Zandu fits almost perfectly into Emamis plans, based on its product portfolio and its digestible scale of operations, the latters willingness to pay a significant premium is understandable. Emami operates with negligible debt (Rs38 crore at the end of March 2007), generates strong cash flow and should therefore manage the acquisition cost fairly well. But the key issue is whether shareholders will be willing to budge. The Zandu stock trades at Rs9,509, about 30% higher than the open offer price. From a minority shareholders perspective, however, current prices seem like a great level to exit with valuations being as high as 40 times earnings. Write to us at marktomarket@livemint.com PTI contributed to this story. Tags - Find More Articles On:

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