The ‘D’ Word: Is India Really At Risk Of Deflation?
Presenting the mid-year economic report card, Chief Economic Adviser Arvind Subramanian has once again thrown out the ‘D’ word. Deflation. A feared economic scenario, deflation is defined as a general decrease in price levels of goods and services. It is brought on either by a surge in supply or a decline in demand. In India’s case, the chief economic adviser appears to fear the latter. Incidentally, this is not the first time Subramanian has raised such concerns. He flagged off similar fears in 2015 when the wholesale price index had slipped into negative territory.
This time around, Subramanian writes in the second volume of the Economic Survey that “deflationary tendencies” are weighing on the economy. The survey goes on to state the four factors that could bring on such economic conditions:
How real are these fears? And does current data give us any reason to believe that India is headed towards deflation?
Disinflation Versus Deflation
It is true that inflation has been trending lower in India. Over the past 12 months, retail inflation has slipped from over 6 percent to under 2 percent now. Data released on Monday showed that consumer price inflation stood at 2.36 percent in July. Wholesale price inflation too moderated at 1.88 percent compared to a high of 5.99 percent in March.
Disinflationary forces are very much in play. But that is not deflation.
To support the idea of deflation, you would need to see not just a lower pace of increase in prices but an actual decline in prices. This would be reflected in negative inflation, which would need to extend to a wide variety of categories. The retail inflation data gives no indication of such a scenario.
A break-up of the consumer price index (CPI) data shows that of the 25 categories within the consumer price index, only three had shown negative inflation or a decline in index levels over the previous year. These three were eggs, vegetables and pulses. In the month of May, only two categories – vegetable and pulses – had shown deflation. The same was the case in January, February, March and April.
Not in any of these months have we seen a broad-based decline in prices of goods and services over a year ago. Core inflation, which is considered to be more reflective of demand conditions, while declining is still close to 4 percent. A professional forecasters survey conducted by the Reserve Bank of India (this is not the central bank’s own projection but a compilation of projections by private forecasters) suggests that inflation will settle at 4.3 percent by March 2018, which would be broadly in line with the central bank’s inflation target of 4 percent.
Is There A Slowdown In Demand?
For skeptics of inflation data, which many, including the chief economic adviser, argue has been way off the mark, there are other ways to gauge whether demand conditions are weak enough to push the economy toward deflation.
Take for instance, the private final consumption expenditure segment of the GDP data. Even as economic growth has slowed from 8 percent in fiscal 2016 to 7.1 percent in fiscal 2017, personal consumption has not collapsed. Private final consumption expenditure rose 8.7 percent in fiscal 2017. This was actually stronger than the 6 percent growth in private final consumption expenditure in fiscal 2016.
Another data point to consider, albeit volatile, is the Index of Industrial Production (IIP). Here, the consumer goods categories, durables and non-durables, have thrown up divergent trends. While growth in consumer non-durables output has been steady at above 7 percent in the April-June period, there has been a sharp slowdown in growth for durables. Overall, growth in industrial output has also slumped from over 7 percent in April-June 2016 to 2 percent in the comparable period this year.
While it would be fair to conclude that demand conditions have softend compared to last year, to suggest that they will induce deflationary conditions may still be premature based on available data.
The Risks That Loom
While current and backward-looking data does not point to deflation, could we be heading in that direction? One risk factor to demand conditions is certainly government finances. State and Centre.
The economic survey highlights that states may be forced to cut back on spending to make space for farm loan waivers announced. It cites the example of Uttar Pradesh, which has slashed capital expenditure by 13 percent to accommodate the loan waiver. As such, these waivers may end up being deflationary rather than inflationary as they would typically be.
A study of state budgets by Credit Suisse dated July 11, had shown that state spending will grow by only 9 percent in fiscal 2018 – the lowest in a decade. The study had gone on to add that center + state spending will be only 20 percent of incremental GDP – the lowest since fiscal 2016. Add to that the fear that the central government may find it tough to meet its fiscal deficit target of 3.2 percent for the current year, and you can certainly foresee government finances being a drag on growth.
Conditions in the rural economy also remain precarious. Stress in the farm loan sector has erupted despite two good monsoons. HSBC, in a report dated July 11, had pointed out that the stress is emanating from landed farmers as wages and debt have risen, while incomes have fallen due to a decline in prices. If so, the stress may prove to be protracted. Nevertheless, commentary from Hindustan Unilever Ltd., India’s largest consumer packaged goods firm, suggests that the management is expecting a gradual pick-up in rural demand. “Looking ahead in the near term, we expect a gradual improvement in rural demand,” said PB Balaji, chief financial officer of HUL in a post-earnings press conference last month.
These risks, along with others highlighted in the economic survey, must certainly be monitored.