It hurts when prices rise and you have to shell out more for everything. So deflation or prices falling should be good, right?  Not really, that's what economists will tell you.

Today, we'll do something really basic yet critical. We will decode these big sounding words called ‘inflation’ and ‘deflation’ and tell you how they affect your returns on investments.

When inflation figures made the headlines last year, it was not really that surprising. All of us were feeling the pinch of prices going up. What we shelled out for petrol, the rents we paid and even what we ended up paying for the so called poor man's fruit - banana's. Yes, prices were definitely up and beginning to worry everyone. This year what's making news? Falling inflation and a new kind of worry - are we hitting zero inflation or deflation in a few months? Which means negative inflation or prices actually falling? Well I can’t see that happening. When I go out to buy bananas, I'm still shelling out 20 rupees a kilo for them, but it is a question we should decode, because economists do worry about deflation. Our question is - should you? 

The Big Question for this week:Should you be worried about Zero or Negative Inflation?

Economists worry about deflation because it means, nobody is buying goods and services and prices are falling. So that's bad for the economy.

First, India is NOT in a deflationary situation by a long shot. Let’s understand deflation first.

Imagine that in 2007 a car cost Rs 8 lakh and you  knew that prices would fall to Rs 7 lakh by 2008 and to Rs 6 lakh by 2009. Would you buy in 2007? Those who could would postpone their car purchase as long as they can. Car companies would cut production, which would mean fewer shifts and job cuts. Less income in people's pockets, would mean lesser cars bought. This widespread downward spiral is called deflation.

The last time the world was in such a situation was in the 1930s and it took sustained government spending in the US and World War II to get out of it.

So deflation is a downward spiral of prices.

But the phone cost goes down each year and so does the cost of making calls, and computers, so isn’t that deflation? Well, there is a good deflation that is due to productivity increases and an overall reduction of costs, like what you see in computers, cell phones and all tech related things. This is a supply side led deflation in prices and is not widespread across all goods and services. What gives economists sleepless nights is the 'bad' deflation - which is there due to lack of demand - when people stop buying anticipating lower prices overall. This sort of deflation usually follows a period of recession.

# So what India has is dis-inflation or negative inflation.

# Due to higher prices last year as measured by the WPI, we are in a period of minus inflation.

# But this is more of a technical statistical fall rather than any systematic fall in demand or negative output.

# India is still growing at 6 per cent and consumer prices are actually up around 9 per cent.

# This fall in the index is due to the commodity prices and fuel prices coming off.

So what's the bottom line for us? Do we need to worry about deflation? No.

There is NO recession in the economy – it’s a slowdown.

Let’s try and figure out how inflations works for your loans and investments. Now, that's really what you and I are bothered about. What does inflation mean to you as a borrower i.e., if you've taken a loan. It’s fairly basic and simple.

Let’s say you borrow 100 rupees and are supposed to repay 110 rupees a year later. If inflation is at 12 per cent, you are better off, aren’t you? You have gained since the real rate of return is now negative for the lender.

The lender gets 110 rupees back but he needs 112 rupees to buy what 100 rupees could have bought last year. So if you have a fixed home loan rate at say 8 per cent and the rate of inflation is at 10 per cent, it makes little sense to prepay that loan.

That's the reason why a little bit of debt in your books is good.

# It forces you to save

# But more importantly, the EMI you pay the end of 10th year will buy you so much lesser that what it will today.

So a long term loan at good terms is actually not a bad idea at all.

As a lender and investor I would like low inflation rather than high and like rates of return to be higher than inflation.

# If inflation is 10 per cent and rate of interest is at 8 per cent, I get 108 rupees but the purchasing power of the rupee is now down

# To maintain the rupee value I need 110 rupees. So as a lender or investor I lose

# Today with FD rates at 8 per cent plus and inflation expected to be down to 3 per cent for the next year, it is a good time to be a lender or investor

# Your real rate of return is about 5 per cent

# To find out the minimum return that is good for you add 2 per cent to the rate of inflation