Inflation in India drastically fell to a two-decade low of 0.44 per cent in the first week of March as food and fuel items turned cheaper, prompting analysts to say that rate of price rise would soon turn negative.
Wholesale price-based inflation declined by 1.99 percentage points from 2.43 per cent during the week ended February 28, fuelling expectations that the Reserve Bank of India would cut interest rates to spur the economic growth.
After a year of spiraling prices, rising inflation, India is now heading towards deflation. The Indian economy may go into deflation by April as inflation is likely to fall below zero per cent. So what is deflation and why is it bad?
Deflation is a fall in the price of goods and services. Deflation occurs when the inflation rate falls below zero per cent. This is the opposite of inflation.
When the inflation rate is negative, the economy is in said to be in a deflationary period.
Why does deflation happen?
A fall in spending -- it could be personal spending or a cut in government expenditure -- leads to deflation. The decline in the supply of money and credit thus leads to deflation.
So, if money-supply decreases; supply of other goods increases, demand for money rises, and the demand for other goods slips, it is deflation.
What are the consequences of deflation?
Deflation leads to a lower level of demand in the economy. It increases the real value of money. It also increases unemployment.
In a deflationary environment, those sectors with a high proportion of variable costs are likely to benefit from falling input prices, according to Goldman Sachs.
What could happen if India slips in deflation?
India would see deflation or reduction in general price level from next month due to slackening demand, according to financial services firm Goldman Sachs said.
"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.
"There will be negative inflation for a few weeks in the first quarter of next fiscal, driven largely by higher base effect but we do not expect a pronounced deflationary trend in the economy," Dun and Bradstreet chief operating officer Kaushal Sampat said recently.
Is deflation good for you as prices are falling?
A fall in the prices may sound good for consumers. But it is not actually good. The lack in demand may push companies to further lower prices.
This can lead to a situation where the prices of product fall bellow the cost of manufacturing a product. This in turn forces the companies to cut production, slash jobs and shut down business till demand picks up. This worsens the situation.
Is deflation here to stay?
Deflation is not likely to last long. The monetary and fiscal stimulus measures of the government is likely to boost demand in the long run. In 2010, however, Goldman Sachs 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 Reserve Bank could slash cash reserve ratio (CRR) for banks by 150 basis points by mid-2009 to provide liquidity into the system.
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