T N Ninan: The new dread-word

The new dread-word is deflation. Google the term and you find it occurring several times in The Economist, Wall Street Journal, Forbes and elsewhere. Lawrence Summers has contributed to the growing chorus with a powerful article this week in Financial Times. Deflation is the opposite of inflation, and we have seen it over the past year in oil, metals, agricultural commodities and many other products. This has given India relief because it is a net importer of oil and metals, but it has knocked down the economies of commodity-exporting nations like Russia and Brazil, while West Asian oil exporters like Saudi Arabia are sweating it out. Those are the early victims.

The fear that has grown is that Europe is slipping into Japanese-style deflation - long years of little or no growth, along with prices continuing to fall. In nominal dollar terms, Japan's GDP now is smaller than it was in the mid-1990s, despite marginal growth in real terms. Europe got the shivers this past week when German exports were reported to have plunged suddenly in August. Already, most European economies have lower GDP (in dollar terms) than they did before the financial crisis of 2008. So: two lost decades for Japan, and one for Europe. China is still growing at a good clip, but it is slowing and beset by troubles. Among the giant economies, that leaves the United States, and its economists are ringing alarm bells.

Sustained deflation causes reduced economic activity. As the world slows down, the International Monetary Fund has been steadily reducing its growth forecasts. India's exports have already seen a fall through 2015. The text-book response to deflation is for central banks to push for economic expansion by reducing interest rates, while governments use the lower interest rates to borrow more and turn on the spending tap. That raises government debt, but if growth is kick-started the increased debt stays affordable. This may not work if interest rates are already close to zero (10-year government bonds are at 0.5 per cent in Japan and 0.6 per cent in Germany, compared to 7.5 per cent in India), so that no monetary stimulus can work. And since government debt has grown sharply since 2008, countries worry about future vulnerabilities if they pile up yet more government debt - but there may be no other option. These dilemmas and difficulties have stirred the fevered debate by leading western economists in leading publications.

What does this mean for India? Consumers have enjoyed cheaper petrol, diesel and cooking gas, so they aren't complaining. But exports have been falling, and it might be difficult to reverse that in a slowing world economy. Farmers who produce agricultural goods for export (cotton and sugar, tobacco and tea) will earn less, and some will be in distress. The makers of cars, garments, engineering goods, polished diamonds and leather goods, not to mention handicrafts like hand-made carpets will face the same trouble - and see jobs at risk. Global deflation also means cheaper and therefore more imports of items like steel, which could threaten domestic producers. The government can respond by raising protective tariffs, but then we move away from an open, competitive economy. Meanwhile, domestic producers of oil and gas have less incentive to explore and develop new oil and gas fields - thereby increasing import dependence for energy. Troubled industries translate into bank loans not getting repaid, and therefore more trouble for banks: the hit in the steel sector is yet to fully show up on bank balance sheets. In other words, sustained deflation is not good news for India either. There is little that the country can do about the global situation, but it can get ready to cope better with what may be coming. That is by improving efficiency and competitiveness through more serious economic reform than has been attempted over the past year.