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India’s problem is disinflation, not deflation

LiveMint logoLiveMint 21-08-2017 Tadit Kundu

The second volume of the Economic Survey released a little over a week ago by the Union finance ministry warned that the Indian economy faces deflation risks owing to the problem of over-leveraged private sector balance sheets and other headwinds such as GST and rural distress. Concerns over deflation risks are understandable, given the recent downward trend in retail price inflation.

However, a Mint analysis suggests that the sharp drop in inflation below the Reserve Bank of India’s (RBI’s) 4% target has been driven by only two items—pulses and vegetables. The analysis shows that consumer price index (CPI), excluding pulses and vegetables, rose at the rate of 3.8% in July, much higher than the official headline figure of 2.4% inflation for the month. The re-calculated CPI is based on adjusted weights after excluding pulses and vegetables from the basket of goods and services.

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The two farm items—pulses and vegetables—have a combined weight of only 8.4% in the consumer price index (CPI) basket. However, they have wielded disproportionate influence over the headline inflation number for more than a year now owing to the sharp volatility in their prices.

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Prices of pulses and vegetables have fallen significantly this year owing to increased supply amid a normal monsoon last year, as noted by the Economic Survey. The high prices of pulses in the year before and the government’s promises of more effective procurement may have encouraged farmers to produce more last year, resulting in a glut. Demonetisation may have added to farmers’ woes by turning farm markets into buyers’ markets, an analysis by the Mumbai University economist Ajit Karnik suggests. These forces have combined to exert downward pressures on prices of pulses.

However, the low prices of pulses this year may lower the incentive of farmers to produce pulses. And together with an erratic monsoon, this could reverse the downward trend in the prices of pulses. Vegetable prices have already begun inching up, the latest inflation data shows.

Several other factors such as GST-linked price increases and hike in the central government’s HRA (house rent allowance) on account of the Seventh Central Pay Commission revisions could also push up the headline inflation number, according to some economists.

Thus, there does not seem to be any imminent threat of deflation in India. A more apt characterization of the recent trends in prices may be ‘disinflation’ (a fall in the inflation rate) rather than deflation (falling prices) given that overall inflation, excluding pulses and vegetables, is close to the RBI target of 4%.

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