HOW DOES INFLATION AFFECT THE STOCK MARKET?
Inflation can be simply explained as the constant rise in prices of goods and services in an economy, such that the value of money goes on decreasing. As the products become more expensive, the spending of the people goes on increasing as they don’t have a choice. When expenditure increases, the amount of money remaining in the hands of people after the expenditure goes on decreasing. This means that the cost of living increases and the purchasing power of the people goes on decreasing.
For example:
Assuming that 1 kg of apple cost Rs. 50 in 2010. And now 1 kg of apple costs Rs. 100 kg in 2020. This means that from 2010 to 2020, there was inflation in the economy. In 2010 you could buy 10 kgs of apples for Rs. 500, but in 2020 you can buy only 5 kg of apples for Rs. 500.
Because of the rise in inflation, the purchasing power of the investors goes down, as they have little funds available with them to invest in the stock market. This, in turn, results in slow motion in the market.
When the inflation rate increases, the Reserve Bank of India (RBI) increases the interest rate on loans and deposits. This means that the borrower has to pay more interest on the loans taken. As loans become costlier, the cost of capital to the companies increases. This, in turn, affects the prices of the shares of the company in the equity market.
As inflation rises, the profitability of the companies decreases, as they have to keep up with the pace of rising prices of raw materials, labor, etc. Due to this, their dividend payout ratio also gets affected as they might not have enough profit to pay dividends to their shareholders.
Stakeindia suggests that one must not invest in dividend-paying stocks during the rise in inflation, as the market value of such companies is more likely to fall.
Stakeindia is the oldest stock market training institute in Nashik, which gives a number of other services like mutual funds, investment plans, Demat account opening, library, etc.
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