Long term Inflation on Big Mac

If I were to tell you Indian Rupees (INR) will weaken significantly and 1 USD which currently buys 50+ rupees will buy 100+ rupees by 2030 would you believe me? Probably not! Read on…

Exchange rates are complex and depends on various parameters like export/import (demand/supply), balance of trade, inflation, growth and money supply. However what is the impact of persistent high inflation in some of the developing countries like India?

Take two countries for comparison – England and India. India seems to have a 25 year average historical inflation of 7%-8% and UK has about 2%-3% during this period. If these inflation rates continue for the next foreseeable future, where does the Big Mac end up at?

Let us start with the approximate 2012 costs – Big Mac costs roughly GBP 2.40 in the UK and the corresponding Maharaja Mac costs about INR 100 in India (equivalent of 1.1 GBP). The graph below examines the cost of Big Macs increasing every year at the historical rate of inflation in India and UK (converted to common currency GBP)

If inflations continue the way they are, it appears that by 2030 Big Macs will cost the same in India and in the UK!  Will this happen? Intuitively this is hard to fathom and doesn’t seem plausible. So, where is the flaw here?

  • It appears that the assumption Inflation rates will remain the same over next 20 years can be challenged. Now, that is true, but while governments focus on growth, there is no real effort to keep inflations in check. So it is not too sure if Inflations will change significantly from the long term average, this is a safe assumption!
  • Countries like India and UK have significant trade balances against them and is not changing in a hurry by 2030 due to the Gold/Oil dependency of India and lack of manufacturing focus in the UK. Balance of trade will continue to be against these countries.
  • So, the most likely explanation for Big Mac prices in the UK being higher in the year 2030 is to be found in the Foreign Exchange rates. This means, the current FX rates which are around 85 INR = 1 GBP is likely to weaken, perhaps to 160 INR = 1 GBP by the year 2030.

Of course, we don’t have a magic crystal ball and one cannot guess what the exchange rates are likely to be, but it looks likely that in spite of all the quantitative easing across the world, currencies with persistent high inflation like India are likely to weaken significantly.

So are you better off keeping your assets in developed economies currencies for the long term?