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)

What the latest WPI number tells us about the Indian economic story

InflationVivek Kaul

Inflation as measured by the wholesale price index(WPI) fell to a eight month low of 5.05% in January 2014. On the face of it, it might seem like a reason to rejoice, but the devil as they say always lies in the detail.
Around 65% of the wholesale price index is made up of manufactured products. The rate of inflation for manufactured products stood at 2.76%. In comparison, this had stood at 4.96% in January 2013.
On the other hand the price of food articles which constitute around http://teekhapan.wordpress.com/2014/02/14/food-inflation-is-down-but-the-figure-raghuram-rajan-is-watching-hasnt-even-budged/14.3% of the index rose by around 8.9%. In comparison, the rise had been at 12.4% in January 2013.
Vegetable prices went up by 16.60% (in comparison to over 30% during the same period last year). The price of rice was up by 13.4% (in comparison to 17.8% during the same period last year). The price of Egg, Meat and Fish went up by 10.9% (in comparison to 11.2% during the same period last year).
If India has to get economic growth going again, the manufacturing inflation needs to rise from its current level and the food inflation needs to fall further.
For more than five years, food inflation has been very high. High inflation has eaten into the incomes of people and led to a scenario where their expenditure has gone up faster than their income. This has led to people cutting down on expenditure which is not immediately necessary.
When people cut down on expenditure, the demand for manufactured products falls as well. This is reflected in the rate of inflation for manufactured products which stood at 2.76% in January 2014. Interestingly, this is also reflected in the consumer durable number( a part of the index industrial production from a use based point of view), which fell by 16.2% in December 2013.
At a more practical level it is reflected in the falling car sales numbers. The domestic car sales number stood at 1,60,289 units in January 2014, falling from 173,449 units in January 2013. The two wheeler sales went up by just 5% to 179,576 units in January 2014 over January 2013.
With high inflation eating into the incomes of people it is not surprising that they are cutting down on their expenditure. Also, high inflation has prevailed for close to five years now. Given this, a fall in overall inflation, as it has over the last couple of months, will not immediately lead to increased consumption. People need a little more evidence of falling inflation before they decide to open up their purses. This means, that overall inflation (as measured through the wholesale price index or the consumer price index for that matter) needs to continue to fall over the next few months, for consumer demand to return. Whether that happens remains to be seen.
While food inflation has been falling, the inflation at the retail level still continues to be strong. If one looks at core retail inflation (i.e. non food non fuel inflation which forms around 40% of the consumer price inflation index) it continues remains to be high at 8%
.
The core inflation contains measures of housing, medical care, education, recreation, transport, personal care etc, basically, everything that is required for a reasonably comfortable living.
If consumer demand has to return, the core retail inflation needs to come down from a level of 8% to close to 5-6%.
What makes a fall in core retail inflation even more important is the fact that the items that constitute it (i.e. housing, medical care, education, recreation, transport, personal care etc) are the ones that consumers deal with on an almost daily basis. And they will not feel inflation has come down, unless the price rise of these items starts to slow down.
This number is closely tracked by the Reserve Bank of India(RBI) as well. The RBI governor Raghuram Rajan had said on January 29, 2014, “that he would have liked to see a greater reduction in core inflation.”
Also, f
ood inflation needs to continue to fall. Its the high price of food that feeds into wages and thus leads to high levels of core retail inflation. Once that is brought under control, consumer demand will return, and will start to reflect in higher manufactured products inflation and a better index of industrial production number (which stood at -0.6% in December 2013).
And that, in turn, is likely to show up in higher economic growth.

The article originally appeared on www.FirstBiz.com on February 14, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek)