Deflation Theory is just a Doomsday Cassandra
Mohan Narayanan

Deflation does not necessarily mean negative growth in the economy

The wholesale inflation nearing zero with all probability of heading into negative terrain is being viewed by classical economists as signs of depression. Nothing could be farther from the truth. Inflation as it is measured today, is on a base of the same period of the previous year. So, if the inflation is resting on a high single digit or a double digit figure of the previous year, then the current year figure is likely to be very low or even negative.

Classical Theory of inflation in a Globalised Economy

The classical theory of inflation being a factor of demand and supply does not hold true in a globalised economy where goods and services cross boundaries with great ease. This of course does not hold good for finite or non tradable asset classes like land and housing. Therefore, unless at a global level there is a shortage, there is not likely to be inflation for commodities like oil, metals, or other tradable goods which are quoted on commodity exchanges around the world.

Inflation and Deflation in India

Let us say, hypothetically that India was registering 9% GDP growth rate and the rest of the world was in recession, then in a similar scenario of high base effect the inflation rate will still be negative. This is because oil prices, commodity prices etc are all based on global demand pattern and if globally there is recession then the prices of these commodities would be low in India irrespective of the demand growth for them in the country.
By the same yardstick in the second quarter of 2010, India will witness very high levels of inflation as the inflation would be resting on a possible negative base rate of this year. This news should not again send us into a tizzy with RBI going into an overdrive and raising interest rates. This will be detrimental to the economy as it will put the brakes on recovery.

Slow growth in India, due to international factors and not a recession

Let us therefore, not jump the gun and raise the red flag on theoretical deductions. No doubt growth is slowing in India due to international factors, but it is by no means in recession. China managed very successfully continuous high growth rates for several years, with very manageable inflation rates although it was continuously pumping money into the economy which under the classical theory should have contributed to very high inflation. We have to change our paradigm and rework the theory to make it work in a more globalised scenario.

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