It’s disinflation, not deflation, we’re facing now

Last Thursday’s inflation numbers — a drop to 0.44 per cent in the wholesale prices index (WPI) — brought more worries that cheers. That’s because deflation — a situation where prices, jobs and incomes keep falling on a sustained basis, and the economy keeps contracting — has become a new cause for worry. Is India on the cusp of a debilitating deflation?

Certainly not, say the experts. “These fears of deflation are unfounded,” Pawan Kumar Bansal, Union minister of state for finance, told a news agency.

Subir Gokarn, chief economist (Asia Pacific) at rating agency Standard & Poor’s (S&P), would agree. He told DNA: “We are not going through deflation, just disinflation. What we have now is inflation coming down. It is coming off a high commodity price base. Deflation is when prices fall very rapidly and we haven’t seen that happening. In a deflation, people stop spending because they believe that prices will fall further. That is not the situation we are in.”

Rupa Rege Nitsure, chief economist at Bank of Baroda, is more categorical. “It is laughable that we are talking about deflation even when the consumer prices index (CPI) is still high.”

Though WPI is falling, CPI is still in double digits at 10.75 per cent. The world over, inflation is measured in CPI, not WPI. The fact that CPI is up means that the price level is still very high. The prices of food, primary articles and housing have still not fallen much. So rather than talking about deflation, policy measures should concentrate on how to bring the CPI down.”

If we are seeing disinflation rather than deflation, what does that mean? Disinflation is a drop in the rate at which prices rise, and does not actually mean a price fall — at least, on a sustained basis across-the-board. For example, the WPI rate was 0.44 per cent in the week to March 7, which means prices actually rose by a tiny percentage. We call that disinflation because the WPI has been falling almost continuously since August, 2008, when the rate nearly touched 13 per cent.

In the coming weeks, if the WPI goes into negative territory, and prices actually start falling, it would still be called disinflation — as long as the fall does not continue indefinitely. On the other hand, the US, Western Europe and Japan are closer to deflation, as their inflation rates are down and economies are actually contracting (see table). It is to counter the threat of deflation that their governments are shovelling trillions of dollars into the credit markets, into failing banks and industries like autos.

But is India really safe from deflationary threats? The short answer to that one is: nobody really knows. If the world economy continues to contract and the US, Europe and Japan enter deflation, India would not be immune.

Laveesh Bhandari, economist with the Delhi-based Indicus Analytics, would broadly agree. He notes that prices have fallen in the last two-three months, but it’s not that they are lower than last year.
“We can say that we are at the margins of deflation — but not deflation itself.” He, too, would look more closely at CPI than WPI, and that is some time away. “In a deflation, prices just fall apart and people dispose of whatever they have. We can’t say that is happening now. Going forward, there could be some stability upwards and some downward pressures, too, but it is not deflationary.”

So what will tell us if we are really into a deflationary scenario? Shashanka Bhide, senior research counsellor at the Delhi-based National Council for Applied Economic Research (NCAER), says the first signal would be a contraction in GDP. “A contraction in output (GDP) is when there will be a worry on deflation. This is happening in the US, where prices are declining and output is contracting. GDP is not contracting in India; there is only a slower rate of growth.”

This, however, does not mean we have no cause for worry, or that deflation will never happen. Subir Gokarn of S&P says that the real problem is credit flow. “More than cutting rates, ensuring the flow of credit is important. If credit does not flow then any amount of interest rate cuts will not help. We have room for cuts, but cuts should be only a part of the plan. The main objective should be credit flow, which is not happening now.”