It is true that a happy economist is hard to find. Take the case of inflation. Gray heads were shaking just last year, stressing that inflation was too high. And now the same people are wrinkling their high foreheads about inflation that is too low. It is not just low, but items such as food have seen a price deflation — images of unsold tomatoes rotting popped up everywhere a few weeks ago. It is important for an economy to get the inflation number right because it impacts growth, wages, tax revenue collection, farmer incomes and gives signals on demand. An overheated engine needs water to cool it, and on a cold, winter morning, it needs a Dhaka (push) start. Like a yoga posture, the inflation number needs to be perfectly balanced — too high or too low signals red.
The October inflation number, at 0.25%, means that prices this October are just a quarter of a percent higher than what they were in October last year. But this number hides the rest of the story, one of actual reduction in prices. We know that inflation is measured by the consumer price index (CPI). An index is made up of the most representative goods and services in our consumption basket. For historical reasons, gold is included under a category called “personal care and effects”. Gold, we can all agree, is an asset and is taxed as one by the government; gold holdings have to be declared in a net worth statement for incomes over 50 lakh. Gold is an asset and not a biscuit. That it should be removed not only from the CPI but also from our current account (it should move to the capital account) is a separate discussion. But should we remove the impact of the price escalation in gold, the CPI for October actually falls by 0.57% over last year. A State Bank of India (SBI) research report estimates inflation to be negative for the next two months, if we exclude gold. As we should.
The other drag on prices is agriculture. Food and beverages were down 3.72% in October this year over last year, vegetables 27.57% and pulses 16.15%. Over-production and lower prices have resulted in rotting crops in some places. Unfortunately, the bleeding hearts disgusted by the farmer having to see his crop rot away instead of reaching the market might be the same people responsible for the farmers’ distress when they agitated for the withdrawal of the farm laws that had the potential to fix this repeated demand, supply and price catastrophe of Indian agriculture.
The Reserve Bank of India (RBI) estimate for inflation for 2025-26 has now fallen to 2.6%, which, the SBI report says, is overshooting its estimate by almost 80 basis points. Basically, inflation will be lower than 2% this year.
Why is this a worry? Household wisdom says that lower prices are better. But the household needs to see itself as a part of a larger story. In that story, there are firms that produce goods and services. Not only does the household consume these goods and services, it also receives wages from the firms. When inflation is too low, it is an indicator of weak demand. This impacts the firms’ desire to produce more and when firms cut production, wages suffer. This further pushes down demand and pushes the economy towards a recession.
There is a third player in this story — the government. The government runs its business by taxing people and firms. The tax is on the nominal and not real value of the production. Governments rely on nominal Gross Domestic Product (approximately real growth plus inflation) to estimate tax revenue. When inflation is low, tax revenues are lower than projected, creating a budget shortfall. This impacts the deficit (the excess of government spending over its revenue) number, which is already under pressure this year, given the income tax breaks and the Goods and Services Tax (GST) rate reduction.
Therefore, governments like a little bit of inflation to keep the economic growth engine humming. How much is just right was fixed by the government — helped by a committee of economists — in 2016 when it arrived at an inflation target of 4% for RBI, with a tolerance band of plus and minus 2%. So, RBI has to maintain inflation between 2% and 6%, with a target of 4%. Inflation falling off the 2% band threshold will be a cause for concern for RBI and a rate cut might be in the offing in December.
Lower inflation for households is good news as they get more out of their money. Together with the GST cuts, it should spur both spending and saving. For households that think the inflation numbers don’t seem to reflect their lived experience, the culprit could be lifestyle choices rather than a problem with data. An inflation-targeting central bank that aims to keep inflation at 4% has an impact with how we target our savings and investments. An RBI working paper found an inflation trend of 9.4% for the period 2007-2014. This will drop drastically in the years ahead. Savers should get ready for lower bank FD rates as lower inflation will keep interest rates in check. Equity investors should recalibrate their long-term return numbers lower than what has been seen in the last three decades. Those planning retirements must continue to use equity to stay ahead of inflation — whatever that number is in the future.
Monika Halan is the best-selling author of the Let’s Talk series of books on money. The views expressed are personal
