CURRENT EUROPEAN DEFLATION: AN OMINOUS SIGN FOR INDIA – BY Dr. BOBBY SRINIVASAN AND Dr. SUDHAKAR BALACHANDRAN

September 18, 2014 | Posted by bobbysrinivasan << back to blog

Mario Draghi, the ECB President, after some resistance moved to lower the Eurozone interest rates from 0.15% to 0.05%. First, he couldn’t believe that the Eurozone has entered into a serious deflation and the recovery is nowhere in sight. The euro which touched a high of 1.37 has significantly dropped in value to currently trade at 1.2850 to a dollar. While this may boost exports from the Eurozone, it is also a sign that unemployment is likely to increase along with business failures due to inflation.

Italy, a Eurozone country, recently announced that the annual percentage change in the Consumer Price Index has dropped to 0%, the level that was witnessed in 2009. Economists say that the drop in the Italian inflation this year is due to a wide range of factors, starting with much weaker economic growth. Earlier this year, Matko Renzi, the Italian Prime Minister, predicted that the gap in growth rate would be around 0.8%. Now, he acknowledges that the current financial year growth rate could be around 0%. While the low inflation rate could lure the Italians back to buying goods and services, the government is getting ready to deal with the deflation. They suspect that the Italian economy could fall into a deflationary spiral where consumer hold of purchases on the expectation that prices could fall even further. Deflation would also raise the real value of the Italians’ monumental public debt of 2.1 trillion euros.

This deflation could spread to the neighboring countries such as Spain and Greece. The global commodity and oil prices are coming down rapidly causing the deflationary spiral to build on. The entire Eurozone is currently facing high levels of unemployment and this deflationary tendency is not going to help in anyway.

What should India do to deal this situation? A significant part of our exports go to the Eurozone countries. We need the Eurozone’s economy to pick up quickly. Otherwise, our current account deficit will continue to widen. The latest data suggests that our trade deficit might be in the range of US $120-140 billion for FY 14-15. With a drastic cut in the gold imports and decline in global oil prices, we would expect the current account deficit to move to less than 2%. This is not going to take place.

Now that President Xi of China is in India to negotiate a number of things among which trade is one of them, Prime Minister Modi should request that the export as a proportion of import should move towards 80% from the current level of 47%. If he succeeds, Indian economy will feel greatly relieved. If the export, on the other hand, does not pick up, we can be rest assured that the currency volatility which we witnessed in 2012 will be back. The global trade is shrinking. Deflation and slow growth among countries are the order of the day. In this environment, our government should continuously strive to improve our global market share. Will they do it? Let us wait and watch.

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