Why zero inflation is bad for the economy

zero

Vivek Kaul

The wholesale price index (WPI) for the month of November 2014 was flat. Hence, wholesale prices in November 2014 were at the same level as November 2013.
For an economy that has been batting a very high rate of inflation, an inflation of zero percent, should come as a welcome relief. Only if things were as simple as that.
The devil, as they say, lies in the detail. The question to ask here is why is inflation at zero percent?
The price of food products which make up for around 14.34% of the index rose by just 0.63% in comparison to the last year. Onion prices are down 56.3% from last year. Vegetable prices are down 28.6%. Nevertheless, potato prices have gone up by 34.1%.
But this seems like a temporary trend and may soon reverse. The kharif (summer-autumn) season has seen a decline in production of most crops, due to a poor south-west monsoon this year. Over and above this, recent data from the ministry of agriculture points out that the total area coverage under rabi (winter) crops has fallen. It stood at 470.74 lakh hectares while last year’s sowing area was at 503.66 lakh hectares.
Several important
rabi crops have seen a fall in total sowing area. As the ministry of agriculture press release points out: “Wheat`s sowing area is at 241.91 lakh hectares as compared to last year’s 251.32 lakh hectares…The area under sowing of Gram is at 71.51 lakh hectares this year while the last year’s figure was 85.75 lakh hectares. Area coverage under Total Pulses is at 111.13 lakh hectares while the last year’s sowing area coverage was 124.78 lakh hectares.”
And this is a worrying sign, which could push food prices up in the months to come.
Another major reason for zero inflation in November is a fall in oil prices. Petrol and diesel prices have fallen by around 10% and 3% respectively in comparison to November 2013. In fact, the government increased the excise duty on diesel and petrol twice since October, else inflation as measured by the wholesale price index would have been negative for the month of November 2014.
Falling food and fuel prices are good news because they leave more money in the hands of people. Nevertheless, its in the third and the biggest component of the wholesale price index where the bad news lies.
Manufactured products make for around 65% of the wholesale price index. The inflation in this case was minus 0.3% in November 2014, in comparison to October 2014. Since the beginning of this financial year, the manufactured products inflation has been at 0.8%. And in comparison to November 2013, the number is a little over 2%.
What this tells us is that manufactured products inflation has more or less collapsed. A major reason for the same lies in the fact that people are going slow on buying goods. This becomes clear from index of industrial production(IIP) for the month of October 2014, when looked from the use based point of view. IIP is a measure of industrial activity in the country.
The consumer goods number is down 18.6% from October 2013. It is down 6.3% since the beginning of this financial year. The consumer durables number is down 35.2% from last year and 16% from the beginning of this financial year. And finally, the consumer non-durables number is down by 4.3% from last year and up only 1% from the beginning of this financial year.
What this clearly tells us is that despite falling inflation, people still haven’t come out with their shopping bags.  When consumers are going slow on purchasing goods, it makes no sense for businesses to manufacture them. Also, that explains why manufactured goods inflation has almost been flat through this financial year.
This is a worrying sign. If consumer spending is slower than usual, businesses suffer and this translates into slower economic growth. Further, businesses have no incentive to expand also in this scenario. The capital goods number in the IIP is down 2.3% from last year.
So why are consumers not spending? A possible explanation lies in the fact that inflationary expectations (or the expectations that consumers have of what future inflation is likely to be) continue to be high. The wounds of high inflation are still to go away. People need inflation to stay low for a while, before they will really start believing that low inflation is here to stay. As and when that happens, they will come out with their shopping bags all over again.
As per the previous Reserve Bank of India’s Inflation Expectations Survey of Households, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent.
Interestingly, today the RBI put
out a press release stating that the October to December 2014 quarterly round of the inflationary expectations survey was being launched. Once the data for this survey comes in, we will come to know where the latest inflationary expectations stand.
If inflationary expectations fall, then it is likely that the consumer demand will improve and the broader economy will pick up as well. If inflationary expectations fall to very low levels, then consumers might also start postponing purchases, in the hope of getting a better deal. Whether that happens, we don’t know as yet. Until then, we will have to wait and watch.

The article originally appeared on www.FirstBiz.com on Dec 15, 2014

(Vivek Kaul is the writer of the Easy Money trilogy. He tweets @kaul_vivek)

Inflation dips, but here’s why Indians don’t believe it will stay low


deflationHere is the good news—the inflation as measured by the consumer price index for the month of October 2014 came in at 5.52%. It was at 6.46 % in September 2014 and 10.17% in October 2013. The price of food products which make up 42.71% of the consumer price index rose by 5.59% in October 2014, in comparison to the same period during the previous year.
A major reason for the fall in inflation has been a global fall in food prices.
The Food and Agriculture Organization’s Food Price Index averaged at 192.3 points in October 2014. It was lower by around 0.2% in comparison to the September number. In comparison to a year earlier, food prices fell by 6.9%. Global food prices have now fallen for seven months in a row, and this has been the longest slide since 2009.
While food prices on the whole haven’t been falling in India, vegetable prices fell by 1.45% during October 2014 in comparison to October 2013. Interestingly, they had risen by 45.7% in October 2013 in comparison to October 2012. Cereal prices during the month went up by 6% in comparison to 12% a year earlier. Also, only two food products showed an increase in price of greater than 10%. The price of milk went up by 10.8% and the price of fruits went up by 17.5%.
Nevertheless, food prices might start rising again. The government has forecast that the output of
kharif crops will be much lower than last year and this might start pushing food prices upwards all over again. As the Business Standard reports “As per very preliminary estimates, India’s food grain production in 2014-15 kharif crop season is expected to be around 120 million tonnes, nearly 9.5 million tonnes less than last year, but officials have said that there could be a further downward revision in the estimates as arrivals gather steam from middle of November onwards.”
And this could push up prices in the days to come. As As Rupa Rege Nitsure, Chief Economist,
Bank Of Baroda told Reuters “recent data shows that towards the end of October we have seen spikes in vegetable prices as well as in cereal prices because of delayed monsoon. So there’s a big question of sustainability of these readings.”
Falling food inflation has come as a big relief given that half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011). Over and above this a fall in global oil prices has also helped. Fuel and light inflation in October 2013 was at close to 7%. In October 2014, the number came in at 3.3%.
Hence, it can clearly be seen that there has been some relief on the inflation front.
For more than five years, inflation in general and food inflation in particular was very high. High inflation ate into the incomes of people and led to a scenario where their expenditure went up faster than their income. This led to a cut down on expenditure which was not immediately necessary.
With food inflation coming down, this should leave more money on the table for people to spend and at least theoretically should lead to a revival of consumer demand and hence, industrial activity. It is worth remembering here that when people cut down on expenditure, the demand for manufactured products falls as well. This is in turn reflected in the index of industrial production (IIP).
The IIP for the month of September 2014 was 2.5% higher in comparison to September 2013. This is a little better than the IIP for the month of August 2013 which was only 0.4% higher in comparison to August 2013. The IIP is a measure of the industrial activity in the country.
The manufacturing sector which forms a little over 75% of the IIP, grew by 2.5% during the course of the month. The number had fallen by 1.4% in August 2014. Hence, there seems to have been some recovery on this front. Nevertheless, it is highly unlikely that recovery will sustain in the months to come.
As Nisture put it “What really matters is that all other indicators of economic activity actually have slowed in the month of October, whether it is PMI, or credit demand or auto sales. So I don’t think that today’s reading of industrial production is sustainable.”
Further, what is worrying are the consumer goods and the consumer durables sectors. The numbers representing these sectors are both down in comparison to last year. When we look at the IIP from the use based point of view it tells us that consumer durables (fridges, ACs, televisions,computers, cars etc) are down by 4% in comparison to September 2013. The consumer goods are down by 11.3%.
What this clearly tells us is that despite falling inflation, people still haven’t come out with their shopping bags.  When consumers are going slow on purchasing goods, it makes no sense for businesses to manufacture them.
Why is that the case despite falling inflation? A possible explanation is the fact the wounds of a very long period of high inflation still haven’t gone away. People are still not ready to believe that low inflation is here to stay. Hence, inflationary expectations (or the expectations that consumers have of what future inflation is likely to be) are on the higher side.
As per the Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year.
The only possible way to bring them down is to ensure that low inflation persists in the months to come. Only then will people start to believe that low inflation is here to stay. And once that happens, it won’t take much time for some consumer demand to return. As Shivom Chakrabarti, Senior Economist at HDFC Bank told Reuters “The real improvement in industrial production will be seen next year when inflation comes down, which will spur consumer spending and exports will be higher.”

The article originally appeared on www.FirstBiz.com on Nov 13, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)