India staring at deflation

India is staring at deflation, or negative inflation, with the official inflation rate this week falling to 0.44%—the lowest since 1977. Food prices, however, continued to be high, with foodgrains roughly 9% costlier than a year ago, reinforcing a cruel paradox for consumers that they hear about zero inflation but face high prices when they buy their groceries. With the wholesale price index (WPI) falling by one point to 226.7 for the week ending March 7, 2009—the same level at which the index was on March 29, 2008—it now means the year-on-year inflation rate will become zero by the last week of March even if the index for the current year falls no further. As most commodities are becoming cheaper with every successive week in the recent past, deflation is expected to set in even before that. The rabi harvest should see a drop in foodgrain prices too, and that will only accentuate the trend. If deflation lasts for some time, as seems possible, it would be a new experience for India. Japan went through a decade-long deflation in the 1990s, termed as the “lost decade’’ for that country. At present, most major economies are witnessing disinflation—a lowering of the inflation rate—and some have also seen deflation kicking in. Japan and China have already reported negative inflation rates in the latest data and there are signs that the US, too, could be heading the same way. While a fall in prices may sound like good news to most laymen, economists see this as an ominous sign of a collapse in demand in the economy. A recent Citibank report echoed this concern in the Indian context saying that the present trend of decline in inflation was not because of any improved efficiency in the economy but because of falling demand.

What is Deflation? A persistent decrease in general price of goods & services. It occurs when the inflation rate falls below zero and stays there for a sustained period .Why Is It Bad? Since the prices of goods are falling, consumers tend to delay purchases until they fall further. This, in turn, leads to lower production, which causes lower wages and demand, leading to further decreases in price. This is called the deflationary spiral, or vicious cycle. Even when interest rates drop close to zero, it doesn't help. Instead, it actually makes things worse as investors opt to hoard money rather than make potentially risky investments ..The Great Depression of the 1930s was a deflationary spiral. More recently, Japan entered deflation in the early 1990s and only emerged after over a decade, called 'the lost decade' Where Should You Invest During Deflation? Look for cos whose sales are not affected too much by prices, like giants in consumer goods, healthcare and utilities Companies which can counter lower prices through higher value-added products or greater economies of scale. Firms with low levels of debt. Cos which had earlier taken heavy debt at high rates see their real cost of debt soar during deflation .