No, low inflation is not always a good thing — here’s why

Yesterday, data released by India’s Central Statistics Office showed that India’s retail inflation, which pertains to the growth in prices of consumer items, had sunk to an 18-month low of 2.19% -- capping a third consecutive monthly decline.

Even wholesale inflation was a casualty, dropping to an eight-month low of 3.80% owing to lower prices of manufactured items.

On a daily basis, the average Indian household could see this as a good thing. Price growth is low, so that means lower expenditure on essential items like fruits, vegetables, pulses, gas, etc. However, this has many implications for the Indian economy and more importantly, investor and business confidence.

However, first things first:-

Where was inflation the previous month and at the same point in 2017?

Retail inflation was 2.33% in November 2018 ( the lowest point since June 2017 ) and a solid 5.21% in December 2017 - which was itself an outcome of higher housing and fuel prices.

Why is inflation so low?

This is largely due to low prices of food items, particularly onions and potatoes, and fuel. In fact, retail prices of food items actually fell by 2.51% reflecting the excess production from India’s agricultural sector.

Meanwhile, retail fuel inflation declined to 4.54% from 7.39% in November 2018 owing to the lower petrol and diesel prices. This was an outcome of the decline in global oil prices. In fact, global oil prices touched yearly lows in December 2018, owing to excess production by a number of countries like Saudi Arabia, the US and Russia and continued exports from Iran. However, with a supposed production cut by OPEC countries this year, inflation might have bottomed out.

Who does it really affect?

While lower food prices are obviously a welcome development for consumers, they can hurt rural incomes. Low food inflation directly translates into lower earnings for farmers and stagnant wage growth in rural areas. Due to a supply glut, farmers usually do not get an adequate price for their commodities despite having similar costs for their inputs, which can make it harder for them to repay their debts.

What does it mean for economic growth?

This means lower consumption from rural India, weak economic demand and hence, lower economic growth. Last week, the Central Statistics forecast that GDP growth for 2018-19 would be 7.2%, well below the 7.6% clocked in the first half of the year, due to the government’s reduction in expenditure in order to keep its fiscal deficit in check as well as lower indirect tax collections.

Low inflation also hurts people other than farmers. If businesses can’t raise the prices of their products, they can’t increase wages, which keeps income growth stagnant. Yes, your raise can get affected.

How will foreign investors and businesses react?

While a stable inflation rate generally makes a country an attractive proposition for foreign investors. However, if inflation is too low it raises concerns about a country’s GDP growth trajectory. Low inflation means less liquidity in equity and debt markets, which will cause investors to steer clear. Correspondingly, low price growth points to subdued consumer demand, which can discourage businesses from increasing capital expenditure.

What will the central bank do about it?

The inflation estimates are well below the Reserve Bank of India’s inflation forecast of 2.7-3.2% for the second half of fiscal 2019. The slowdown in price growth raises the possibility that the RBI will reduce interest rates when its Monetary Policy Committee meets next in early February 2019. The monetary policy stance is also expected to shift from “calibrated tightening” to “neutral”.

It will do this in order to spur aggregate demand and consumer/business confidence by making loans cheaper. An increase in credit-fuelled consumption will provide a boost to the prices of items and economic growth as wages and profits rise. This, coupled with the RBI’s continued liquidity injection through purchases of government bonds, portend for a stronger GDP result in the final quarter of 2018-19.

More importantly, with an eye on elections, the government will likely try and sustain farmer incomes by providing price support for specific commodities as well as cheaper loans and an income support scheme.

Global oil prices are expected to tick up this year, but it remains to be seen if the increase will be substantial enough to drive inflation up considerably by the end of the financial year.


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India’s retail inflation rate just hit its lowest point since June 2017, raising the prospects of a rate cut and more handouts to farmers

Reserve Bank of India surprises all by keeping interest rates unchanged