India seems to be headed for a short and mild bout of deflation. The problem is that borrowing costs are rising despite this, as an oversupply of government bonds pushes up interest rates. Three months ago, inflation clocked at 8%; now it’s at 2.43%.
We wonder what Pandora’s box may be slowly opening.
Like inflation, India’s Index of Industrial Production, too, continues to fall; the markets learnt on Thursday that factory output this January was lower than what it was last January.
Consider also the bond market. On Thursday, the yield on the nine-year note was 7.17%; three months ago it was just 6.45%.
Deflation should have lowered the yield curve, in the indication of imminent risk; yet, the yield curve paradoxically keeps rising and getting steeper.
Why? The reason here is the oversupply of government bonds used to finance a rising fiscal deficit. The increasing yield, in turn, ensures rising real interest rates.
Pump-priming, supposed to increase liquidity in the system, may just be having the reverse effect.