New Delhi: Even as the inflation scare that gripped India in the middle of 2008 recedes from memory, the spectre of deflation hovers on the horizon.
Citigroup economist Rohini Malkani said in a report on the Indian economy, released on Thursday, that the Wholesale Price Index (WPI) between June and September could be lower than its level in the same months of 2008.
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HDFC Bank Ltd chief economist Abheek Barua is another economist who believes that price indices will go into reverse gear in the middle of the year. “With the current pace of deceleration in inflation and no reversal in the commodity price cycle in sight, inflation may turn negative for three to four months this year,” he said. August will see inflation hit a trough of -1.8%, he predicts.
The government said on Thursday that wholesale price inflation has dropped to 5.24% for the week ended 3 January, an 11-month low. The sharp fall in Indian inflation in recent months is in tune with price trends in other countries, as slowing growth, lower equity and home prices and job losses have led consumers and companies to hold back on spending. Prices of commodities such as crude oil and steel have also tumbled from the multi-year highs in the middle of 2008.
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But most economists believe that inflation will move back into positive territory once the so-called base effect—or the high inflation numbers a year ago—wears out. Malkani forecasts that government programmes to stimulate demand and depreciation of the rupee that will increase the prices of imports will help push up inflation later in the year. But it is unlikely to regain its recent highs. Citigroup predicts that average inflation in fiscal 2010 is likely to be 3% compared to an estimated 9% during the current fiscal year.
Comparing inflation rates from one point of time to another has its pitfalls, because either a high or a low starting level could lead to exaggerated trends a year later. The spurt in inflation measured by the official WPI after July is one reason why annual inflation will be close to or below zero in the second quarter of this fiscal year.
National Council for Applied Economic Research director general Suman Berry warns against reading too much into point-to-point calculations of inflation that predict declining prices. He mentions another metric—GDP deflator—is a more trusted indication. The GDP deflator measures inflation by converting the value of national output at current prices to its value at constant prices. “The real question is will average inflation for 2009-10 show a deceleration compared to 2008-09. I doubt it,” Berry added.
Economists draw a distinction between deflation and disinflation depending on the length of the episode. While economies such as Japan have battled falling prices for more than a decade, others have experienced shorter bouts of falling prices. Sustained deflation is a danger because consumers tend to perpetually postpone buying decisions in the hope that prices will fall even more. India is unlikely to have such sustained deflation anytime soon, say economists. Central banks and governments are usually more concerned about a Japan-like situation than what is likely to happen in India this year.
The fact that only a short burst of deflation is expected in the middle of 2009 is one reason why the bond market has not priced in such a possibility. Long-term bond yields tend to drift below short-term yields when there are episodes of sustained deflation. That has not happened in Indian bonds right now.
But the yield on 10-year government bonds fell on Thursday after the announcement of the new inflation data, though they are higher than recent lows reached earlier in January. The expectation in the bond market is that yields will decline further as the falling inflation will gives the Reserve Bank of India (RBI) ample room to cut interest rates further. However, according to dealers, bond prices already reflect the possibility of zero inflation later in the year.
“The bond market is expecting near zero or negative inflation by March or April—which can be termed as disinflation but not deflation. Current bond yields have already discounted this factor,” said Joydeep Sen, vice-president, advisory desk, BNP Paribas Ltd.
According to Anindya Dutta, managing director and head of capital markets at Calyon Bank Ltd, yields on 10-year notes will fall to 4.5% as inflation continues to come down.
However, Prime Minister Manmohan Singh’s economic advisory council (EAC) chairman Suresh Tendulkar does not expect deflation. “Commodity prices are declining but food inflation will remain positive. Put together, I don’t think the whole thing (wholesale price inflation) will come down that drastically,” he said. He added that the council’s position on this will be further clarified in an update to its economic outlook for the current fiscal, likely to be released in a couple of weeks.
CARE Ratings Ltd chief economist Soumendra K. Dash agrees with Tendulkar. “We do not foresee any potential deflationary trends creeping into the economy in the near term. RBI and the government have been taking various proactive measures to spur effective demand through massive infusion of liquidity and expansionary monetary policy,” he said. Low interest rates, higher government spending and faster growth in money supply usually behave as an antidote to slow growth and falling prices.
Edelweiss Securities Ltd had in a November report said large infusions of money by the developed countries to break the shackles of recession may stem the crash in commodities. RBI has also pumped in Rs3.2 trillion into the financial system to tackle a liquidity crisis. A weak rupee may also take away part of the benefit of reduction in inflation of imported items, the firm added. But it also forecast the “possibility of near-zero WPI inflation during certain periods in second half of 2009.”
Anup Roy in Mumbai contributed to this story.
Graphics by Ahmed Raza Khan / Mint