The Hindu Business Line : The negative side of inflation

Rather than debate whether the negative inflation rate is a statistical outcome, the need is to avert a deflationary cycle, especially with the looming threat of drought and falling demand, says S. VENKITARAMANAN.

The Reserve Bank of India has announced that the wholesale price index (WPI) showed a negative rate of increase — or decrease — during the week ended June 6. The rate settled at around -1.61 per cent compared to the relatively high 11.66 per cent during the corresponding week last year. The increase during June is attributed to the Government’s decision to raise — albeit belatedly — the domestic prices of petro-products.

This statistical explanation conceals the fact that wholesale price indices generally reflect a change from the base. It is not much use saying the rate has decreased because the base was high. The index number problem has always been a complex one. What is significant is that in a country that’s seen persistently rising wholesale price indices, there has been a negative change.

Time to celebrate?

Should it be a cause for celebration or mature reflection? The answer depends on how we look at it. Basically, the development reflects a decrease in commodity prices globally due to the recession unfolding in the US and translating to similar decline in demand elsewhere.

Overall, the decline in inflation to negative territory has raised fears of deflation. Deflation arises when prices continually drop and people postpone consumption anticipating a further fall in prices. This is a vicious cycle leading to falling output and consequent decrease in GDP, lowering incomes and pressing demand further — a scenario that characterised the 1930s’ Great Depression. People are making grim comparisons between the Great Depression and the recent recession. However, observers point out that the decline in WPI does not amount to deflation as our macroeconomic numbers are improving.

This is partly borne out by the fact that GDP growth for the third and fourth quarters of 2008-09 were positive. The index of industrial production turned around recently, showing there is no deflationary spiral at work in India. Hence, it is reasonable to assume that the recent negative rate may well be statistical in origin.

Monetary policy

However, this beneficial outcome may not last as oil prices have begun increasing globally and could result in an inflationary trend in India. What does this presage for RBI monetary policy? Irrespective of the reasons for the negative inflation rate, there is no justification in demands for inflationary targeting and tightening monetary policy. The RBI should take a sympathetic view of the decreasing rates of interest and adopt a more accommodative money supply.

Some observers have cautioned that food prices may rise as a result of poor monsoon. Whether that calls for tighter monetary policy is, of course, debatable. A more accommodative policy is required given the need to increase demand in the country. The combination of negative inflation and volatile oil prices has come at a difficult time, especially because of the erratic monsoon behaviour, which may lead to drought anytime. The country will face shortages of both demand and liquidity. Such a situation would call for improvisation on the part of all policymakers.

Fine-tuning price indices

Incidentally, the time has come for the central bank to restructure its approach to the price index. This writer has pointed out that other countries, both advanced and developing, have focused on consumer price index (CPI). The RBI has rightly stated that the CPI varies for different categories of consumers in India and it prefers a combination of WPI and various CPIs. It has also mentioned that the weight of food products in the CPI is higher than in WPI, leading to higher increases for CPI than WPI in recent times.

Other countries have solved the problem of varying CPIs in a structured fashion. The RBI should appoint an expert group to resolve this issue in our country. Issues arising from a negative WPI cannot be resolved merely by restructuring price indices. Whether we like it or not, there is a deflationary trend in the economy which has been complicated by factors such as a deficient monsoon.

Longstanding solutions

The present problems remind me of the late 1960s when the agricultural reformer Dr M. S. Swaminathan occupied the centre stage in Indian agricultural policymaking. That was a time when two American economists had predicted drought and food shortages in India. Some Leftist elements saw in this a conspiracy by the US to sell its surplus wheat to India.

Fortunately, however, the then Food and Agriculture Minister, Mr C. Subramaniam, decided to take the bold step of arranging for PL-480 loan to avert the impending food shortage. At the same time, with the able assistance of Dr Swaminathan, he converted the challenge of famine into an opportunity. History records how the combined efforts of these two leaders initiated the Green Revolution, which has played a leading role in the country’s fortunes during the past three decades.

It is fortunate that Dr Swaminathan is active in Parliament and can guide our leaders in finding longstanding solutions to the current problems. This would involve not only agricultural policy but also credit and monetary policy.

It is hoped that the RBI will utilise the WPI figures to spur growth in the present context. Rather than debate whether the negative inflation rate is a statistical outcome, the need is to avert a deflationary cycle, especially with the looming threat of drought and falling demand.

blfeedback@thehindu.co.in

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