February 18, 2020
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The Dagger Under The Cloak

Low inflation may be a boon for the consumer, but a cascading effect of the price wars could throttle growth

The Dagger Under The Cloak

Mid-summer, '98. Prices of food items are going through the roof. Potatoes up four-fold, tomatoes five-fold, lemons six-fold, coriander ten-fold, culminating in the onion crisis towards the year-end. Economists warn of impending stagflationóa situation where rising prices could send an already-dismal economy down the tube. The middle class does what it canóboycott the onion and vote the bjp in Delhi and Rajasthan out of power.

Mid-summer, '99. The inflation barometeróthe wholesale price index (wpi)ótakes another unprecedented swing. The official rate touches a 17-year low of 1.83 per cent and analysts see a decline to 1 per cent.

Many see this as scary. 'We need stable prices. This isn't a nirvana-like state of low prices, low unemployment with steady growth. Rather, prices are falling in a situation of slack demand, incomes and investment. This is a symptom of the recession. It sucks the economy in a spiral,' says Wilima Wadhwa, executive director, Society for Economic Research and Financial Analysis.

It's often said that when predicting crisis, economists usually look a long way up the tracksóonly to be hit by a train coming from the other side. Is the train of deflation then about to hit the economy?

First, the numbers. By end-November '98, prices of agricultural products started falling on kharif arrivals and by January, helped by a drastic cut in diesel prices, the wpi fell to a one-year low of 4.43 per cent. Since then, both wholesale and consumer prices have been falling, mainly due to the easing in the prices of daily consumption items like wheat, tea, mustard and edible oils till the wpi fell below 2 per cent for the week ending July 3.

Many analysts have a problem with these figures. For one, they say the inflation rate does not reflect the reality of prices. It talks of wholesale prices and not retail. Even on wholesale prices, the basket of goods is unrepresentative. 'The inflation rate as represented by the wpi speaks of a mythical consumer with a mythical basket of consumption items,' says S.L. Rao, former director-general of ncaer.

Why mythical? The basket of goods was chosen in 1981-82. Many of the goods are either not around or not consumed now. For example: what do you say about an index that tracks the prices of Ambassador and Premier Padmini but not that of Maruti when computing car prices? So what if you can't see Campa-Cola in the market, perhaps it still dictates price of beverage to wpi compilers!

A question mark hangs over the way inflation is measured. 'This-week-over-last-week, this-year-over-last-year can't be a good way of calculating it. It has to be an average rate over a few months,' says Rao. Otherwise, it becomes statistical jugglery to be used by politicians to their advantage. 'The main reason I think why the inflation rate is low this year is the high-base last year,' agrees economist Subir Gokarn.

The methodology may be questionable, but it's no new phenomenon. So, why raise the issue now, argue those who would rather look at falling prices as reflected in items of primary goods and items of daily use. 'The ground reality is that a good harvest has kept vegetables prices down. In the manufacturing sector, intense competition is leading to product discounts. Incomes are stable and not fuelling a demand push. That's pushing prices down,' says Wadhwa.

Initially, that's music to an average consumer's ears. 'Low prices mean that you do not need a big raise to get ahead,' says Sandeep Jain, an executive with a travel agency. Low prices also mean a field-day for bargain hunters. 'Today you can haggle over anythingófive-star hotel tariffs, airfares, cars, TVs. Remember when Maruti up front took Rs 2 lakh and made customers wait for a year? Now they run after you with zero-interest finance schemes, wrist watches and gold coins thrown in and big price-cuts. It's sweet revenge,' says businessman Naveen Bhatia.

That's inflation on the ground. 'The downward spiral is here to stay and a reflection of a more open economy. Trade taxes are down, foreign investment up and quantitative restrictions going. As the market takes over, we'll see less of the demand-supply mismatches and thus lower inflation,' argues economist Surjit Bhalla. 'The more globally aligned the economy, the less it'll see local and political factors influencing prices as was the case with the onion crisis,' he adds.

Do we then have a rosy picture ahead? Actually, no. Falling prices may benefit the end-user, but it's a double-edged sword. A good harvest is a bonanza for consumers but bad news for farmers as prices dip. 'There are tremendous inefficiencies in the retail and distribution channels and the demand-supply balance in key agricultural commodities quite precarious so that the primary producer gets a small realisation even out of high retail prices,' says Gokarn. If the producer's share in the consumer rupee goes on shrinking with small realisation out of retail prices, the farm sector will face severe price disincentives.

Lower prices sometimes create a downward spiral in which expectation of falling prices reduces demand and pushes prices lower still. That seems to be happening in segments like consumer durables and branded consumables like biscuits, tea and edible oils. 'We're not like the Americans who think why cut on consumption when incomes are growing faster. We save when prices are up to cushion a future price rise. When they are low, we postpone spending in anticipation of further cuts,' says Deepak Sud, finance manager with a multinational.

From the investment angle, lower prices may make heavy borrowing unwise. They push up real interest rates and also increase the real burden of existing demand.

How long will the fall last? Will low inflation make the economy emerge or submerge? Many industries actually need to worry. Most at risk are cars, computer chips, steel, chemicals and those with excess capacity. Gluts will maintain pressure on prices even if demand picks up.

Overall, though, most analysts see the current depressed price scenario as a temporary phenomenon. Despite increases in international oil prices, a large part of the increase has not been passed on. Pre-election, the caretaker government is unlikely to effect any rise in administered prices but post-polls, the new government would be hard-pressed not to do so. Defence spending is also likely to shoot up with Kargil bringing into focus the need to upgrade defence equipment. With the sectoral trends showing signs of a pick-up in cement dispatches, housing loans, automobiles, diesel consumption and finished steel, commercial lending to corporates would shoot up, putting more money into the system and leading to higher rates of inflation. The high government deficit will also pressurise prices.

'Till next summer, if the economy grows, the inflation rate should be back to 6-8 per cent,' says Rao. 'A bit of inflation is not bad. It's better than the current scenario when low prices are not stimulating investment and growth,' says Wadhwa.

In the meantime, nobody can grudge the consumers a temporary respite. The party is unlikely to last long.

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