My disinflation is actually your deflation

When two star economists of a country have contrary views on the economy, confusion is warranted. So when India’s chief economic adviser Arvind Subramanian uttered the "D" word on September 2, there was a gasp of sorts from economists and policymakers. "Deflation" was last heard in 2009 when worries of a contracting—deflationary economy where a fall in prices, jobs, incomes became a part of India’s narrative for a few months and the pressure on the Reserve Bank of India (RBI) was immense at the time to cut interest rates. Inflation had nosedived from 12.8 per cent in August 2008 to 0.7 per cent in March 2009.

A deflationary scenario is considered as a precursor to a depression-like situation. The two most prominent periods of deflation were associated with the Great Depression of the 1930s in the US and Japan’s "Lost Decade" of the 1990s. The term deflation is often confused with disinflation, which means a slower pace of inflation in which prices are still rising but at a lower rate, and that is what India is experiencing, according to RBI governor Raghuram Rajan.

India at the moment is nowhere close to deflation, say economists. When the chief economic adviser cautioned that India is at the risk of deflation — “Price-wise, the Indian economy appears to be in or close to deflation territory and far away from inflation territory” — and the RBI governor insists otherwise, who should one believe? Placing pressure on the RBI to cut interest rates is not new; the finance ministry in the recent past has been rather overt in this exercise and the chief economic adviser’s statement once again was a manifestation of that.

Subramanian has been arguing that the central bank should look at both the wholesale price index (WPI) and the consumer price index (CPI) for inflation targeting — WPI has been in the negative territory for nine months while the CPI slowed to 3.78 per cent in July. The RBI has set a target of containing retail inflation to six per cent by January next year and the central bank bases all its calculations only on the CPI. National Institute of Public Finance and Policy professor N Bhanumurthy argues that the announcement made by Subramanian is based on the WPI number and that’s a “concern” as the WPI has limitations such a lesser coverage and that is creating confusion among policymakers. “We should discontinue releasing WPI numbers,” Bhanumurthy adds.

Internationally, there is a disinflationary situation and there is an expectation that the situation might aggravate as China’s growth declines. Since India is not a net importer and prices of nearly 30-40 per cent of commodities in the Indian consumption basket are regulated and not driven by market forces, this makes the deflationary forecast for India a bit exaggerated.

However, having said that, the RBI might be on the back foot with its inflation target. Many economists say that the six per cent target set by the Urjit Patel Committee is on the higher side, considering CPI is hovering around four per cent and that the RBI is perhaps 50-75 basis points behind on rate cuts. “Even if we look at CPI, the recent correction in the momentum gives adequate underpinning to RBI to cut rates,” opines Shubhada Rao, president and chief economist, Yes Bank.

According to a DBS Bank research note, most of the preconditions set out at the time of the policy review in August by the central bank have been fulfilled. However, it is also true that some of the states are on the verge of declaring a drought and that will fuel food inflation. DBS Bank estimates September-December CPI inflation to average at five per cent, below the six per cent target.

While India continues to be one of the brighter spots in the world, the real GDP rose seven per cent in the April-June quarter versus 7.5 per cent in January-March domestically, the private sector continues to struggle across verticals, corporate balance sheets are under pressure and credit offtake has been tepid. Research firms, brokerage houses and rating agencies are revising India’s growth forecast downwards — ratings agency Moody’s revised India’s growth forecast downwards to seven per cent from 7.5 per cent in 2015. In such a scenario, it is “important to see monetary policy stance as part of the overall revival strategy”, says a policy expert. But the government still has a big role.

Front-loading of fiscal spending and some activity in the roads or highways sector is likely to influence GDP numbers for the rest of fiscal 2016. The timing of the rate cuts will also be influenced by the US Federal Reserve rate decision and China-linked volatility.

Economists say India has negative inflation but not negative inflationary expectations. Household surveys show that nobody believes there will be negative inflation. Or, as a policy expert says, the finance ministry could be resorting to being fictitious here.