India's annual rate of inflation fell further in the week ended Feb 14 to 3.36 percent , a figure that is far less than the peak rate of 12% less six months back. So, inflation is  dipping at a good pace. Is it a good sign for the economy? Or is it the right time for the government to hook inflation to prevent deflation?

A few weeks ago, it was an unimaginable situation. An alarming inflation rate was inching higher and higher making the country's policy makers, business communities and the common men tense and nervous. Not just India, all major economics in the world were facing a nettlesome situation while rising inflation was in everyone's mind. There was a global food crisis, oil prices were rocketing up, the world was heading towards recession, and the rest is history.

The gloomy economic phase in world economy is still not over but the monster of inflation is shackled and tamed down now. In India, as mentioned earlier, it is satisfactorily below 4%; in the US, the annual inflation rate is hovering right at 0% (according to Bureau of Labor Statistics) while  annual inflation in the broader 27-member European Union is expected to edge down to 1 per cent in February (it stood at 1.7 per cent in January). In all major economies, price growth is getting razor-thin, and as a result, the concern about deflation is gathering momentum.

What is deflation? Why it is dangerous to an economy? What happens if the inflation dips down below zero percent ? Inflation is referred to as a rise in the general level of prices of goods and services in an economy over a period of time. When the inflation rate slows down but remains positive, this is known as disinflation. Deflation, on the other hand, refers to decline in general price levels. It is often caused by a reduction in the supply of money or credit. It can also be brought by a period of general economic decline when there is a sharp decline in government spending, personal spending or investment spending.  

Lets' discuss, in layman's language, why inflation and deflation both are bad boys? When the cost of goods and services increases, the value of a rupee falls as you won't be able to purchase as much with that rupee as you previously could. A high inflation rate benefits debtors and makes creditors suffer; people (or creditors) who invest their savings in banks, retirement funds, etc. are paid back less in real terms than the amount they lent. Deflation, in contrast, is brought when there is a sustained general fall of prices of wages, goods and services. it is a reduction of inflation overtime. Who benefit from deflation are creditors and those who suffer from it are debtors. Such a situation is avoidable, as it may lead to bankruptcies.

Is India really on a deflation precipice? In the last few years, Indian economy is growing in excess of 9%. The Bombay Stock Exchange went up from 5,000 to 21,000 in the last few years; there was a boom in all the major industrial sectors including  real estate properties, IT services, Cements, Food products etc. There were huge demands in the market and everybody thought that the growth will continue forever. But suddenly everything collapsed - demand plunged -a gloomy phase in the economy started, equity markets crashed shedding more than half of its points, interest rates went up and people started losing jobs. As a result, there was a general fall of prices - commodity prices went down by over 70%, real estate saw over 40% drop, and so on. It sounds just like a symptoms of deflation.  

Is deflation really creeping into the Indian economy?  Or is this just more sensation than reality? Some major economics like Japan, US, China and Europe are already under deflationary pressure as there is a lower level of demand. In India, the situation is not so worse. The inflation rate is lowering down but still it is above 3%  signaling our economy is only in a period of  disinflation, not deflation. True deflation is far more than mere specific commodity price movements; it is triggered by declines in the prices of a broad range of goods and services. Moreover, India is blessed with a massive domestic market which means we are less likely to be affected by a demand slump at international market.

But prevention is always better than cure. The government need to hook inflation in and around 2-3%. Already, it has announced several stimulus packages but that is not enough for the economy. The US Federal Reserve has cut interest rates down to a near-zero range as the consumer prices are declining. But in India, lending rates are still close to 10% which seems quite high when we look at the current inflation rate showed last Thursday. Cutting interest rate will encourage the corporate sector to try something new and consumers to buy more. The inflationary pressure is low enough now and therefore, it is an opportunity for the RBI to reduce the interest rates.

The bottom line- higher inflation is certainly not good, but deflation is much more dangerous. Therefore, a balanced inflation rate is necessary to maintain. The government needs to take proper monetary and fiscal steps to avert a deflationary spiral. At this moment, deflation is not a risk for Indian economy but today’s gloomy consumers can make everything happen in the future. So, an eye should be kept on the ball in regards to the dreaded 'd' word.  
 

Note: India's inflation plunges further since Feb 14

2009 Feb 21 - 3.03%
2009 Feb 28 - 2.43%
2009 Mar 07 - 0.44%
2009 Mar 14 - 0.27%  
2009 Mar 21 - 0.31%
2009 Mar 28 - 0.26%
2009 Apr 04 - 0.18%  
2009 Apr 11 - 0.26%
2009 Apr 18 - 0.57%
2009 Apr 25 - 0.70%
2009 May 2  -  0.48 %
2009 May 9  -  0.61%
2009 May 16-  0.61%
2009 May 23 -  0.48
2009 May 30 - 0.13%
2009 June 6 -  -1.61%
2009 June 13 -  -1.14%
2009 June 20 -  -1.30%
2009 June 27 -  -1.55%