Monday, October 25, 2010

Deflation is more dangerous than Inflation !

Deflation is more dangerous that Inflation !

Economics is a simple science which is too complicated, said Churchill. This
statement is proved true today, with conflicting reports about inflation and

Inflation is measured using the WPI ( Whole Sale Price Index ). When
inflation becomes negative, it becomes deflation. For example, say WPI at
June 06,2007 was 200 and on June 06, 2008 was 220, then we say, inflation
was ten percent. If on June 06, 2009 the WPI was 231, then we say that
Inflation is five percent more than last year's.

On June 18, 2009, the Govt announced that India is under deflation.

If deflation is prolonged, then it is very dangerous, more dangerous than
inflation. It will engender crisis and recession. More than prices falling,
it is the expectation that prices will fall, that is more dangerous. If
consumers believe that prices will fall furthur, investment decisions will
be delayed. My friend was saying he will not buy a flat of 80 lakhs now, as
he will get it for 40 lakhs after two years. Consumer judges that it is a
Bear Phase and will not invest and will wait for prices to fall. Let it be
Stock Market or Realty, the intelligent will only enter at the end of the
Bear Phase and not at the beginning. !

Inflation is the phase where the prices of products and services go up in a
bullish curve and Deflation is the phase where the prices of products and
services go down in a bearish curve !

The prices of some commodities - particularly foodstuffs - are rising during
even the deflationary phase. The Wholesale Price Index is based on 430
commodities. Ordinary people are bothered only about the prices of
foodstuffs, rice, sugar, wheat, fish, vegetables etc. The prices of copper,
coal, aviation fuel etc, ( which is also included in the 430 commodities )
are something the common man is not bothered about. The common man does not
benefit when the price of aviation fuel comes down. But the prices of
foodstuffs do not come down and this explains why prices of some commodities
are rising during deflation.

Now this inexplicability is resolved when everything is based on the CPI,
the Consumer Price Index.

The Wholesale Price Index on June 06, 2008 was 236.5 and on June 06, 2009
was 232.7 and hence Deflation is 1.61%.

Now Consumer Price Index can be followed as it highlights the prices of
essential commodities and if we follow the CPI, we have an inflation at 8% !
Inflation was 11% when oil was ruling at 140 dollars per barrel. The
inflation of today is merely a statistical aberration.

People will delay their buying during Deflation. During inflation, when
people thought price of rice was bound to go up, they bought heavy
quantities of rice. Now the reverse phenomenon will happen during deflation.
The buying of rice, wheat, medicines etc which are essential will be
deferred. There will be less demand. The manufacturers will have to slash
down output. There will be retrenchment of employees as business becomes
slack, unemployment will rise and the whole economy will be affected

From 1990-1996, Japan was under deflation. The World Financial Crisis is
here to stay. Global economic deflation is at 2%. Global income will come
down 2%. In Japan, Singapore, Dubai and Russia income will come down by 8%.
Of the G 20 countries, only India and China has recorded good growth. In
2009, China will grow by 7% and India by 6%.

Now India has grown by 5.8% during this global recessionary phase and this
shows the resilience of the nation. The export sector has become weak. But
then the industries led by consumer demand like steel, cement, cars, two
wheelers do not face recession at all. We can expect a 6% growth this
fiscal, if no adverse factors hit us. There should not be any deflation in
an economy with more than 4% growth, according to Economics. Even if
deflation hit us, it will only be a temporary phenomenon.

Whether Inflation or Deflation is more dangerous is an interesting debate in
Economics. High inflation and prolonged Deflation are equally dangerous. For
a developing country like India, moderate inflation is ideal. A 3% inflation
is ideal and necessary for a healthy Indian economy.

The resurrection of the primary market

The IPO market is back in action. It was more or less dead after 2008, when
the market fell sharply. This year 2 companies had cancelled their IPOs due
to bad market conditions in February.

Mahindra Holidays and Resorts is coming with an IPO on June 23. 92.66 lakh
shares are the initial public offering.

The Sensex is at 14.5 K levels. One wonders whether this rise has anything
to do with the IPOs which are going to come to the market !

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