India Nears Deflation

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Mar. 20 – Within a span of just seven months India has moved from a 16 year high inflation rate of 12.91 percent to a 32 year low inflation rate of 0.44 percent. The situation however represents a cruel paradox for consumers as food prices continue to rise during the deflation – food prices rose roughly nine percent year on year.

Deflation in India which is a result of the economic crisis and a subsequent cut in domestic demand, is threatening to lower growth in production and investments. Broking house CLSA  has predicted that India’s GDP will grow by 4.6 percent in 2009-10, and that the domestic economy will stabilize only by early 2010. Further, it has projected public sector deficit to rise to 14 percent of GDP in 2009-10, and the rupee to fall to 57 to the dollar by the end of this year.

A negative inflation discourages investments in the economy. The real interest rate difference between nominal interest rate and inflation becomes very high, making funds costlier. As demand goes down, capacity utilization of manufacturing units declines. This discourages investment in capacity expansion, the Times of India said quoting a Citibank report "India Macroscope”.

The Indian government is doing all it can to spur consumption and investments. The RBI cut interest rates to 5 percent for the fifth time in the first week of March and the FIPB reduced restrictions on FDI cap. Nonetheless while domestic demand is low, exports continue to fall – exports fell to a 10 year low slumping 16 percent year on year.