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5 things to know about deflation in india
For a long time, India faced the ugly problem of high inflation - the rise in prices over time. Costs jumped at a fast pace month on month. This forced the Reserve Bank of India to maintain a high-interest-rate policy.
Now, the problem has reversed. For the past five months, inflation has been in the negative zone. Inflation measured by the Wholesale Price Index (WPI) fell to negative 2.33% in March, the lowest in 65 weeks. Deflation has set in.
Here are five things to know:
What is deflation?
It is the exact opposite of inflation. Deflation is when prices fall over time. This happens because either demand falls a lot or companies produce much more goods and services than required. Either way, sales continues to fall, forcing companies to give discounts or price cuts to attract consumers. This leads to a fall in prices over time.
Why it matters?
Just like inflation, deflation can be a continuous cycle. When prices continue to fall over time, consumers can withhold spending money. This is because they wait to buy the goods or services at a lower rate tomorrow. This means demands continues to fall, leading to further deflation. A fall in sales is not good for company profits. As a result, companies too withhold investing in new projects. All this leads to a slowdown in the economy. Countries often struggle to get out of this deflationary spiral. Japan, for example, has struggled with deflation for nearly a decade. This has kept its economic growth depressed.
Is India at risk?
Deflation has hit countries in Europe and Japan. Even in Asia, seven out of 10 countries excluding Japan are facing deflation, according to a Wall Street Journal report. India has now joined this list after reporting a fall in prices for the fifth time in decades. However, analysts suggest there are no reasons to worry about deflation in India. This is because the demand scenario in India is not affected. The key reason for deflation is the fall in global commodity prices. After years of high inflation, the fall in prices could very well help improve demand for goods and services in India. This will help accelerate economic growth further, not slow it down.
Not for you and I:
There are two ways to measure inflation - Wholesale Price Index (WPI) and Consumer Price Index (CPI). The latter is what really matters to consumers like you. It measures the actual change in retail prices. WPI inflation has fallen into the negative territory the last few months, not CPI. Retail inflation still stands at 5% levels. This means retail prices are still rising, although at a slower pace than earlier.
Room for rate cut:
One of RBI's key responsibilities is to keep inflation in check. To do so, it tweaks interest rates. By increasing lending rates, the RBI aims to make loans costlier and thus, discourage borrowing. This, in turn, is expected to discourage spending. As people spend less money, prices stop rising and inflation moderates. Deflation, in contrast, gives the central bank room for cutting interest rates. As result, hopes are high for another rate cut. However, some analysts expect that the RBI would wait for further data on CPI inflation, global oil prices as well as monsoon before cutting rates further.
A key reason for the deflation as measured by the WPI is the fall in fuel prices. It accounts for 15% of WPI's measure. In contrast, fuel holds only 8% weight in the Consumer Price Index, which also accounts for price of services. As a result, the WPI is more sensitive to the change in fuel prices than the CPI. This is the reason behind the difference in inflation measured by the WPI and CPI indices.