India Enters Into Deflation Mode

The rate of inflation turned negative for the first time in 30 years at minus 1.61 per cent, causing a flutter among industry and economists, but the common man continues to pay more for pulses, cereals and vegetables than in 2008.

Inflation at week-ended June 6 came in at -1.6 per cent, heralding the wholesale price index (WPI) heading into negative territory for the first time since 1977-78. The annual rate of inflation, calculated on a point-to-point basis, stood at -1.61 per cent for the week ended June 6 as compared to 0.13 per cent for the previous week ended 30 May and 11.66 per cent during the corresponding week of the previous year. The WPI for all commodities was up 0.04 per cent at 232.7 WoW.

Negative Trend of Inflation
The negative trend of inflation is likely to continue till August 2009 after which the impact of the high base effect is likely to wear off. The decline in inflation should pave the way for further interest rate cut by the Reserve Bank of India (RBI) that in turn would help to revive industry, which is impacted by shortfall in credit, and infuse liquidity in the market.

According to Government figures, the prices of food articles were up 8.7 per cent: those of pulses, the only cheap source of protein for vegetarians, is up by 17 per cent; cereals by 13.5 per cent and fruits and vegetables by 10 per cent. Sugar prices have gone through the roof. There are two factors that have brought in this "negative inflation". The prices of commodities and crude oil have come down compared to the prices a year ago, when both these items were at their peak. The wholesale price index, on which the inflation index is calculated against the prevailing price in the corresponding week a year ago and not a week ago.

Now that prices are falling, this is a good time to do away with administered oil prices and link them to the market. Even if they lead to some rise in other prices as well, through linkages with the rest of the economy, it will hardly be painful if it brings price rise from a negative to a zero per cent increase.

Concerned industry wanted immediate action like cuts in interest rates to boost demand even as bankers opined that interest rates could be cut by up to one percentage point.

After the inflation data were released, the stock market rose 200 points from the opening level but closed the day lower at 257 points at 14,265 points even as some economists said that the situation warranted Government action.

Impact of Food Prices
Cheaper food prices dragged the index down but the fuel prices remain an area of concern. The prices of oil are kept stable even though the international crude oil price is rising, once the domestic prices are revised then inflation will start zooming up again.

However, the negative rate of inflation number of 1.6 per cent showing that the WPI dropped compared to 2008 reinforces the trend that has been seen since November 2008. In fact, had the statistical office been putting out the correct number that is the seasonally adjusted month-on-month figure, as do all countries with even a modicum of a well-run statistical system, we would have clearly seen the fall in prices that has been taking place since the crisis in the last quarter of 2008. Price deflation since November 2008 has been quite sharp.

The Government needs to intervene to rationalise the negative zone inflation as it reflects slowdown in production activities with the piling up of inventories due to lack of demand. The government has hinted at the possibility of hiking the retail prices of petrol and diesel, a move that is sure to fuel inflation. The rather contradictory signals from the inflation data — negative inflation as measured by the WPI, with a strong possibility of a spike a few months hence — pose a new challenge to monetary authorities. The build-up of huge fiscal deficits over the last two years and the difficulties in effecting fiscal consolidation are major concerns, though the existence of excess capacity in many sectors should provide some cushion.

Revival of Economy
Recently the International Monetary Fund (IMF) has predicted that India will grow only at 4.5 per cent while the RBI’s prediction is 6 per cent Gross Domestic Product (GDP) growth. Obviously, there is confusion because a slower growth rate would mean a slower revival of the economy and more problems for the unemployed. All economic indicators point to the continuation of a slowdown but the mood is somewhat upbeat among official circles which keep insisting on a high rate of growth of about 7 per cent in the next one year, and the Prime Minister himself has said that the country will be on its way to recovery soon.

Foreign Direct Investment (FDI) inflows might pick up as people realise that India and China are still somewhat better sheltered from the global crisis. A revival of the stock market will bring back confidence of foreign institutional investors. But there will be tough competition in attracting Foreign Institutional Investers (FIIs) among the emerging economies.

Negative inflation rate indicates that there is room for further rationalisation of the interest rate structure in order to boost demand in the economy.However, there was no fear of deflation and this was just a temporary phenomenon.