India : Vacillating from inflation to deflation .

Couple of quaters back , Indian strategic planners and economists were crying hoarse about the double digit inflation which was perceived as the single biggest threat for then incumbent Congress government. As the Lok Sabha elections are less than a month away, we see a real possibility of India plunging into deflation, as this report indicates. This finding has been collaborated through both indian and western outlooks (refer :Goldman Sach report) .

Hearing people ramble (continously...) about these issues and National Dailies cluttered with some kind of analysis (usually oxymoronic ) on a daily basis now , i thought of chipping in my 2 cents of gibber too !! ;)

What is inflation and deflation?

In Layman terms, inflation is a generic increase in price levels and deflation is a general decrease in price levels (of goods and services). Further notes about inflation can be found here and deflation can be found here. ( Did'nt want to use Ctrl+c and Ctrl+v)

Simply put, in an inflation type scenario, goods priced at Rs. 100 at some base year would now be Rs. 110 and in a deflation type scenario, they will be Rs. 90.

What were the causes of inflation in India's case?

Clearly there were a lot of factors which led to India's high inflation phase during the mid-late 2008 period. But 3 most important causes were Huge increase in oil prices, increase in domestic demand and supply side uncertainty which lead to hoarding of goods. What does all this mean? India imports 70% of its oil and hence any price change(both increase or decrease) will have a huge impact on India's expenditure. As all of us aware, oil price touched all time high $140 per bbl range in the second -third quarter 2009 , something that could be attributed to the huge speculation generated demand in the international oil futures market. This meant that there was a huge increase in India's expenditure as compared to the earlier years. This meant that levels in the domestic market increased thus leading to inflation.

What are the causes of deflation in India's case?

In India's case, the prominent causes of deflation are low money supply, curb in spending by households, industry and govt and whats known as the base level effect. Base level effect ,very simple terms, if in earlier years, the price levels are high(to the point of insanity!! -very much true !!), then, a drop in price levels(basically, a return to sanity) would be reflected in the economic terms as deflationary movements. India, being traditinionally cash- conservative pro-saving society , will have more pronounced tendency to hoard and thereby , triggering deflation .

Now, what impact will deflation have now?

From our experience in 2008, we all know that inflation is bad for the economy. But hold on, deflation is even worse(trust me !!). In a deflationary scenario, firms have no incentive to produce goods. Example, if you were a FMCG manufacturer in a deflationary economy, would you produce biscuits, soap, etc ? Definitely not as much as you would normally produce, coz you know that the price is going to reduce. What this means in a national context is that firms may layoff employees (as a cost saving measure) thus leading to unemployment. Perhaps the pay packets may be slashed, incentives may be reduced. Clearly, deflation isn't a great situation to be in.So which economic condition is good .Clearly, high inflation as well as deflation isn't good. Whats best for the economy was what India experienced from 2003 to 2007 - single digit inflation which was under government's control. That creates optimal condition for the growth of all stakeholders in the economy.

Now ,what does this mean for the upcoming general elections?

The incumbent government is bound to suffer; but the question remains, is the opposition 'opportunistic enough' to take advantage of these weaknesses? Clearly, only time and and will tell how things will shape up! ( by that time Rs 10000 cr will have gone down the drain !!)

But one thing is for sure, this will have a huge impact during the general elections!

Adios !