Has inflation become extinct?

By S. Swaminathan

Widespread sentiment of diffidence and stagnation have seized many sections of Indian business during recent months. It is the combination of a creeping domestic economic slowdown which has been at work for more than two years and the onset of a recessionary phase in the global economy. Conventional economic thinking tends to forecast a further deterioration before the economy really starts rebounding. Even if a `slowdown phase' cannot be expected to generate inflationary expectations, what seems to be happening in the economy on the `price front', is somewhat intriguing with inflation coming down to exceptionally low levels.

Inflation at a new low

Price data, which are available now for the week ended October 20, establish, even if provisionally, that the inflation rate, measured in terms of the Wholesale Price Index (WPI) is 2.72 per cent as against 7.32 per cent at the corresponding point of time last year. Nor is this a sudden crash of prices caused by some panic that the American war against terrorism cannot but engender large-scale dislocation of economies not excluding the developing countries.

A scan of price movements in the Indian economy over the period April-August this year would show that the year-to-year inflation rate based on WPI, has been hovering around 5.3 per cent, as compared with an average of 7.7 per cent for the preceding six months. Broadly, the wholesale prices for primary articles and manufactured products had moved within a narrow 3-5 per cent range for about 12 months now.

During 2000-01, if the inflation rate had reached a 7.1 per cent level, it was largely due to the escalation in administered prices of petroleum products by around 28.5 per cent! With the Central Government choosing to keep the administered prices of petroproducts unchanged this year (despite the oil pool deficit growing to a level of over Rs. 12,000 crores), this otherwise inevitable trigger for an inflationary movement of the price level has been kept out of mischief.

It could well be that the annual average rate of inflation during the current year is kept even lower than at 4 per cent as contrasted with the projection of about 7 per cent implicitly made in the Union budget for 2001-02. If it turns out this way, the inflation rate could defy the presumed pressures of a high fiscal deficit (of perhaps 5.5 per cent of the GDP) and a not-so- moderate expansion of money supply at around 15 per cent.

Does all this mean, therefore, that the economy has achieved a structural transformation which would enable it to cruise at a near 6 per cent growth altitude without fuelling inflationary expectations? Have low inflation rates (associated with the developed economies) become an integral feature of the liberalised Indian economy?

Significant pointers

If the hypothesis of low inflation rates becoming a characteristic feature of the Indian economy can be validated, then a number of interesting policy implications would follow. First, budgetary and Plan outlays need not be mechanically stepped up year after year to provide for the `price factor'.

Second, the obsession with nominal interest rates (attached to contractual savings) or the fixation that the level of savings in the economy is critically dependent on a subsidised system of small savings which are pegged to guaranteed rates of interest (independent of the rate of inflation) and are made eligible for tax concessions, would be rendered obsolete.

Third, if inflationary expectations are toned down across the spectrum of economic transactions, excessive speculation in commodity and securities markets could get automatically dampened. There could occur, even a general contraction in transaction costs all around, with export competitiveness gaining strength. Over a period, the rupee could even appreciate as against the U.S. dollar and other strong currencies.

And the counterview

The statistical evidence we have, of inflation getting moderated (in terms of WPI), cannot be squared with the ``cost of living" experience of millions of people spread over the country. So long as we cannot measure inflation on the basis of a universalised cost of living index, it would be unscientific to speak of the benefits of a WPI-based inflation moderation. Then too, there is the conventional economic view that low prices are often indicative of a ``low-level equilibrium". In the Indian context today, moderate inflation is not expression of economic maturity but manifestation of demand deficiency and idle capacity. So should we set store by low inflation as an abiding feature of the economy, reposing unwavering confidence in the Reserve Bank of India as a powerful sentinel of price stability?

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