The Phenomenon of 'Deflation' in India

Deflation is a general decline in prices, which is often caused by a reduction in the supply of money or credit. Everywhere one looks, prices are falling. The major reason for deflation is the decline the consumer spending due to a reduction of general demand in the economy. Deflation can also come due to high base effect, which is an impact of high inflation last year on the current level of the rate of price rise. The real danger to the economy is that due to the large negative demand shock, deflationary forces get entrenched, leading to a vicious cycle of falling output and declining prices.
Deflation hurts the economy much more than inflation. Consumers postpone expenditure, because they think prices will be cheaper going forward. This affects firms, who then scale back production and investment plans, leading to job losses, further affecting purchasing power and demand, which leads to a downward spiral in the economy. At the same time a deflationary environment, those sectors with a high proportion of variable costs are likely to benefit from falling input prices.
Monetary policy, although it has been loosened considerably, still has considerable room left to ease. Monetary policy alone, however, will not be enough. The onus will then have to fall on fiscal policy. In particular, there needs to be additional stimulus. But at the same time we have to be cautious about the possible ‘crowding out’ phenomenon in the economy.
The slowdown in the economy translates into lower wages and job insecurity further dampens consumer confidence setting off another deflationary cycle. It takes years for an economy to recover when it is caught in a prolonged downward spiral. Is India about to enter this cyclical downturn?
The current deflation is a temporary phenomenon, mostly because of the base effect and the impacts of external shocks. The WPI and CPI are already started showing an upward trend. After the general elections about 20,000 crores of rupees is being pushed to the economy. Consumption demand is expected to receive a boost once the lagged effects of the aggressive policy responses by the Government and the RBI start unfolding. The rightly intervention of RBI through cheapening of credit and reduction of deposit rates will help to pump more money in to the economy. This will generate consumer demand and thereby help to create more output, employment and income in the economy.