Officials allay deflation fears after inflation hits all time low

Indian officials brushed aside concerns about deflation after the country's annual rate of inflation based on the wholesale price index fell to a historic low of 0.44 per cent for the week ended 7 March 2009. (See: Inflation rate hits a record low of 0.44 per cent). 

This is sharply lower from the previous week's level of 2.43 per cent (provisional). The inflation rate was 7.78 per cent during the corresponding week of the previous year.

Inflation is now at the lowest since the current data series began in 1995 as Asia's third-largest economy slows.

"It is more indicative of a base effect rather than any price effect," cabinet secretary, K M Chandrasekhar said on the sidelines of an industry conference in New Delhi yesterday.

Deflation occurs in an economy when the negative inflation prevails for a long period.  This uneven declination may raise scope for Reserve Bank of India (RBI) to further lighten in its monetary policy. Last year, RBI had adopted tough measures to tighten the spiraling inflation.

"In sectors which cater to domestic demand certainly the worst is over," Chandrasekhar said, adding that there was a revival in sectors such as automobiles, cement, steel and infrastructure. This would help an economic recovery, he opined.

The latest figures are a huge reversal after inflation in India reached a 13-year high of 12.9 per cent in 2008.

Arvind Virmani, chief economic adviser at the finance ministry, told reporters during the Confederation of Indian Industry meeting in New Delhi on the first week of March that there is no chance of a deflation in the country.

''After the first and second quarter of 2009-10, growth may be slow, but thereafter there will be improvement in the growth rate'', he said. (See: Indian economy not prone to deflation: Virmani). 

The government predicts economic growth will slow to 7.1 per cent in 2009 after three years of about 9 per cent expansion. That would be the lowest level of growth in six years.

Trade secretary G K Pillai said inflation would not be a concern for the next two - three months, but some analysts say policy makers would be in a dilemma over further rate cuts as the consumer price index is still over 9 per cent in annual terms.

Deflation is a sustained fall in price level and it is caused by a collapse of aggregate demand. A sustained decline in demand also leads to recession but not all recessions have deflation, an expert said.

The examples of deflation are the Great Depression in 1929 that impacted all economies and Japan in 1990. Recession with deflation tends to be prolonged (Japan is still suffering), posing chronic problems for policy makers.

For India, the possibility of deflation is remote, Pillai opined.

There are several reasons for that he said adding that the the number is not final and could be revised upwards. Also, private consumption still forms around 60 per cent of GDP and is expected to be steady, preventing prices from falling due to lack of demand, he said.

Goldman Sachs sees deflation
According to financial services firm Goldman Sachs India would see deflation or reduction in general price level from next month due to slackening demand.

"We expect yearly headline WPI inflation to fall rapidly below 1 per cent in March... And enter a period of deflation beginning in April, which could last till end-2009 due to not only continuing demand destruction but also a sharp step-up in the base," it said in a research report.

In 2010, however, it expects inflation to come back due to both a gradual pick-up in demand, and conversely, a low base from 2009.

It further said that the RBI could slash cash reserve ratio (CRR) for banks by 150 basis points by mid-2009 to provide liquidity into the system.

"A combination of falling primary and fuel prices, and a high base from last year have led to the sharp fall in inflation this week," an economist with a foreign analytical firm said. He expects deflation to begin in India by April.

"We are looking at deflation by the last week of March. It will have a stabilising impact on bond yields in the days to come," said a chief economist at a private sector bank. "It also gives the central bank that much more headroom to keep cutting rates."

According to an IMF study published in January only 13 countries are prone to 'moderate' risk of deflation based on 2009 projections, such as Germany, Italy, and France. The US is on the border to high risk. Only Japan exhibits clearly high risk. However, risks of a debt-deflation spiral in Japan are lower than 10 years ago, owing to improved balance sheets of the banks and the nonfinancial corporate sector.

However, IMF forecasts a slow down in Indian economy to 6.25 per cent growth this fiscal year and 5.25 per cent in 2009-2010 after and average growth of 8.75 per cent during the past 5 years.