New Delhi: You can call it the D-word debate.
Economists are in a bind these days: Indian headline inflation measured by wholesale prices has dropped to near-zero, but consumer price inflation still hovers around 10%.
And then there is the problem of how to describe the drop in headline inflation—as deflation or disinflation?
Deflation denotes falling prices while disinflation means that the rate of inflation is falling. There is a world of difference between the two—and hence in the way they should be tackled.
Some economists dislike the term deflation, even as quite a few analysts have been using it to define the current economic situation, as it exaggerates the problem. They prefer to call it “disinflation”. At the same time, they would prefer if it was used to highlight the downside risks to the economy if the global economy does not correct its southward drift immediately.
Deflation is the opposite of inflation. It is broadly defined as a situation when prices drift downwards, even as demand contracts as jobs and incomes get squeezed, which if not corrected could set in motion a vicious cycle of contracting incomes and jobs and in turn trigger another round of fall in demand and prices.
While government economists rubbish the suggestion of deflation, terming it as a mere “statistical phenomenon” due to a higher base effect during the same period last year on account of high commodity prices, other analysts disagree.
Inflation based on wholesale prices declined to 0.44%, the first time in two decades, during the first week of March and may well turn negative. In fact, some economists aver that it would remain negative till December. The International Monetary Fund has projected an average inflation rate of 1.9% for India in 2009-10.
P.K. Padhy, economic adviser in the ministry of commerce and industry, whose office releases the headline inflation data, terms the present situation as “disinflation”. “This is not deflation, rather disinflation. In a deflationary situation, decline in prices is combined with contraction in production. Even if we take the third quarter GDP data, the economy is growing at 5.3%,” he says. Padhy says the high base effect and measures such as excise duty cuts under the stimulus package are key factors and expects it to be “short-lived”.
Other government economists such as Prime Minister’s economic advisory council chairman Suresh Tendulkar and chief statistician of India Pronab Sen argue similarly.
However, Surjit Bhalla, economist and managing director of Oxus Research and Investments, an economic research, asset management, and emerging-markets advisory firm, terms the proposition as “absolutely insane”. “Inflation rate started falling since September, when there was no base effect. Even the GDP price deflator for the September-December quarter shows inflation rate at 1-2% which means price pressure is close to zero. Whatever you call it, there may be technical differences. But the fact is there is no price pressure in the economy. The focus should be to cope with that reality.”
Citigroup, in a report on the economy released earlier this month, said that while India’s deflationary patch is likely to be due to a high base effect and supply-side issues and be temporary in nature, it cautioned not to ignore the demand-side factors. “With both investment and consumption coming off, continued policy action is necessary to stem the deceleration in growth.”
It further maintains that while deflation would result in policy rates coming down further, it could increase the problems in the real economy as expectations of falling prices would likely trigger a further reduction in consumption demand. “This results in less demand, lower production, and weak economic growth,” it added.
While economists differ on whether or not this is deflation, they are united in their view that a policy palliative is imperative.
C.P. Chandrasekhar, professor in economics at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, says that “demand deflation” is also partly responsible for the current situation. “However, all of it is not due to demand deflation. In some commodities, price inflation is still occurring,” he adds.
Though he does not term the current scenario deflation, he disagrees with the term disinflation. “Typically, in a deflationary situation, due to curtailment of demand, there is so much accumulation of inventories that the producers cut down their production and prices.”
However, to wardoff “demand deflation” factor, he asks for more targeted fiscal measures by the government along with direct government purchases and expanding the scope of public distribution system.
Bhalla warns if the current situation persists, the outlook would worsen and further dent business confidence, contrary to the view of government economists who feel the “statistical phenomenon” will have absolutely no impact on the economy. “As the monetary authority was trigger-happy in controlling inflation, they should be equally trigger-happy in tackling a deflationary situation. The Reserve Bank of India should cut policy rates much further,” he added.
In fact, given that consumer inflation for industrial workers is at 10.45% January, some economists believe the time may have come to replace the existing measure of headline inflation.
“The current WPI (Wholesale Price Index) inflation is calculated upon a base year which is 15 years old (1993-94). Though it is debatable whether this underestimates or overestimates inflation, however, it does not reflect the ground reality. A more representative inflation index is needed, not necessarily for the current development,” Padhy said.