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How indexation adjust inflation

What is inflation and Indexation and How indexation adjust inflation ? Should one invest in fixed deposit?







tThe government has discontinued the indexation benefits from the financial year 2025, announced in the Budget for FY-2025.


First of all let's understand what is inflation in a layman terms. The general rise in prices is called inflation. This rise in prices may be due to many reasons from demand side and supply side. For example, if supply remains constant and demand for a particular item increases its price will also increase. And if demand for a particular item decreases it's price will also come done if supply remains the same. Same way we can say that if supply of a particular item increases in the market at constant demand then it's price will decrease and if supply decreases and demand remain same, then the price will increase. Inflation affects your income. That why the government gives dearness allowance (DA) to the employees and dearness relief (DR) to the pensioners. You buy or sell or invest inflation always affects you. 

Investment and inflation :-

One has many options to invest his/her saved money. People think fixed deposit very safe as it gives guaranteed return and doesn't depends upon market volatility. Suppose one has invested his money in a fixed deposit at 7% rate of interest for a year. He is happy that his money is growing at the rate of 7% every year. Is he right? No, he is not right. He is ignoring inflation. His money is not growing at the rate of 7% . Let's understand why so ? Suppose the rate of inflation in that year is 4%. So, his money is growing with 7% - 4% = 3% only. This 3% is the real intrest rate which he actually will get. This is called natural or neutral rate of interest. So, now he will be disappointed and hate the inflation. 
Inflation always affects you. It never leaves you alone. Every year you see price rise. It makes you irritated.
But, inflation also help you to grow. It is very important for the economic growth. It is an incentive to the manufacturers and producers. 

Indexation and Inflation:-

The biggest sector which benefitted from inflation was real estate. But the government has  discontinued the indexation benefits from financial year 2025, announced in the Budget for FY-2025. Now, let's understand what is this indexation. In a layman language it is the index which adjust inflation in the price of property. It is called cost inflation index and the base year is 2001-02. Let's understand it with a example. Suppose a person buy a property of 20 lakh in 2010. He sold it for 50 lakh in 2024. You may think that he earned a profit of 30 lakh. So, according to you he has to pay capital gain tax on 30 lakh . But it was not like this. Here the Cost Inflation Index (CII) comes to the picture to save that person. Suppose the CII(Cost Inflation Index) in 2010 was 160 and in 2024 it is 320. So, to eliminate the inflation from the property price the formula is : 
Buying Price multiplied by CII of the selling year and divided by CII in the buying year. In our example it will be like this: 20 lakh into 320 divided by 160. It will be 40 Lakh. Means the value of that property in 2024 is 40 Lakh due to inflation. He sold it for 50 lakh, so he earned profit of 10 lakh only and not of 30 lakh which seems without adjusting inflation. This is how inflation is your friend. But, from financial year 2024-25 the government has done away this indexation to calculate capital gain tax. So, now the inflation can't save you from higher capital gain tax in buying and selling property. As per this new change, in our example that person has to pay capital gain tax on 30 lakh instead of 10 lakh. 
I hope you have clearly understood that how indexation adjust inflation and save you from capital gain tax. The union government recently announced in the budget for FY-25 that now onwards there will be no indexation benefits. So, it is going to increase capital gain tax. It will harm the property dealers in the real estate sector as there will be reduction in buying property for selling after few years to get profit. But, good news for the person who wants to buy house for living purpose because now property rate will not increase as fast as earlier.

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