Signs of Deflation?

This is perhaps the most intriguing paradox of a nation’s economy. There is great concern when there are inflationary trends and there is similar concern when there are indications that the country could be getting into a spell of deflation. In fact, there is legitimate reason for people to be more worried about a spell of deflation than about inflation because a spell of deflation tends to last much longer than a period of inflation. The example of deflation that most readily comes to mind is the spell that Japan went through in the early 1990s and was able to come out of only more than a decade later. It affected the economy of Japan so adversely that the Japanese refer to this period as their "lost decade".

Indian economists are beginning to worry because the present inflation rate is at a 32-year low of 0.44 per cent and threatens to fall below zero and stay there for some time. This is a strange situation to be in, because less than a year ago we had the inflation rate at above 12 per cent. There was some panic at that point because people linked the high rate of inflation to the unprecedented spurt in crude oil prices in the Persian Gulf and with the global meltdown that seemed to have hit the United States harder than many other countries. However, the crude oil prices came down as sharply as they had gone up. From around $147 a barrel, the crude oil prices slipped to below $40. The price index lost no time in hurtling down as did the overseas value of the rupee. But why are people so concerned at the fall of prices that hints at a deflation around the corner? It is because a deflation is, among other things, like a leech: it sucks the blood out and tries not to let go. In the first place, when prices of goods start falling, people tend to delay buying things (especially consumer durables) until prices fall further. But this leads to lower production (because people are not buying) and eventually to lower wages. Coupled with lowered demand, this leads to further decreases in price. This is what is known as the deflationary spiral or the vicious cycle. When this happens, it could lead to large-scale layoffs and loss of jobs. Loss of incomes leads to further belt-tightening and a deepening of the crisis. That is when interest rates start dropping close to zero. This could have helped the borrower, but there are not too many of them around. On the other hand, investors become tight-fisted and tend to hoard money rather than making investments that could be potentially risky. However, India is not the only country experiencing a drastic lowering of the inflation rate with deflation knocking at the door. Japan and China already have negative inflation rates, and there are clear indications that the US could also be following suit.

Perhaps the only difference in the case of India could be that many of the established economic principles do not always work in the case of India. One reason is that the parallel black economy of the country is huge in size and has always managed to influence the official economy. In India, things like the per capita GDP are at best notional because of the size of the black money economy. As such, once we have deflation, there are strong possibilities of a sizeable part of the black money coming out into the open. After all, in times of crisis like this most people who hold on to their white money would be less worried about having to spend their black money. In fact, one could even hazard a surmise that a lot of the black money hoards would begin to dissolve in people’s attempts to maintain the same standard of living. Since white money with lower interest is going to be difficult to part with, people are more likely to tap their black money hoards — both at home and abroad. For all we know, this alone could give India an edge over many other countries in a similar situation. One must also take official figures with a pinch of salt in an election year. THE SENTINEL