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?
What is deflation and why is it bad for the economy?
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 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.
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.
Is deflation good for the consumers 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 are likely to boost demand in the long run.
Regards,
Gaurav
CAclubindia
