Deflation – the how and why!
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Deflation? The only word I understand is deflating a cycle tyre,” laughed Kalabala Silva, the often-agitated academic.During a Thursday morning phone conversation, we were discussing the latest economic term to describe the country’s economy. Last week, the Central Bank said Sri Lanka had entered an era of deflation.
There are three terms that govern rising or falling prices via the Cost of Living (COL) – inflation (when prices rise), deflation (short definition – when prices fall) and stagflation (short definition – persistently high inflation).
“So does deflation mean we’re encountering a period beneficial to the consumer,” asked Silva. “Not really. There is no easy answer – it’s a yes and no response,” I said.
Deflation is generally described as a general decline in prices for goods and services. A senior Central Bank official I spoke to said deflation is a situation where prices fall compared to inflation where consumer prices rise. In the long term it can be destructive, he said, pointing to the example of Japan (which is widely used to describe the effects of deflation) which acutely hurt the economy.
When deflation occurs, another phenomenon is that producers make losses which in turn affect the economy. “We have seen a sharp rise in consumer prices in 2022 and the early part of 2023. COL is still high even though inflation has come down,” he said, adding that supply side factors become negative in the economy.
Consumer prices are yet to come down to the pre-COVID-19 and pre-economic crisis times. During the COVID-19 followed by the economic crisis, prices and inflation hit the roof and consumers were unable to bear the costs, with many families in the low-income category having to forego a meal and cutting the nutritional intake in their daily food consumption.
“We don’t expect deflation to continue for a prolonged period as it would dissipate after the second quarter of next year,” the Central Bank official explained.
According to a widely-held explanation, while “deflation may seem like a good thing, it can signal an impending recession and hard economic times”. When people feel prices are headed down, they delay purchases in the hope that they can buy things for less at a later date. But lower spending leads to less income for producers, which can lead to unemployment and higher interest rates, according to this explanation.
Whew! After another technical explanation on an economic factor, I simply needed a breather. Walking into the kitchen, I picked up my mug of tea which was nicely brewed by Kussi Amma Sera and also a ‘maalu paan’ (bakery-man Aldoris had done his rounds this morning) and looked towards the margosa tree where the trio had gathered for their weekly chat.
“Pol mila adehiya nohaki vidihata wedi wela. Den minissu ganney pol gedi bagayayi mae davas wala (Coconut prices are unbelievable. People are buying half a coconut these days),” said Kussi Amma Sera.
“Aanduwa monawa karaida danney nae, mila pahalata genna (I wonder what the government will do to bring down prices),” noted Mabel Rasthiyadu.
“Egollanta pol pita ratin genna wewi, mokada apita pol ona-nae sambola hadanna. (They may have to import coconuts. We need coconuts for pol sambol),” said Serapina.
Coconut industry officials said the industry is still affected by the after-effects of the fertiliser ban imposed several years back. Some weeks ago, before the new government was elected, the authorities were contemplating importing coconut kernels to assist the coconut export market and make sure there was enough local production for the domestic market.
Back to the discussion on deflation, the Central Bank said the deflation rate was 0.5 per cent, the first instance in many years where deflation was recorded. It said in a statement that the food category experienced a year-on-year (Y-o-Y) deflation of 0.3 per cent in September 2024, a significant shift from the 0.8 per cent inflation recorded in August 2024.
It said that according to the latest projections, it is expected that headline inflation will remain negative in the next few months, deeper than previously projected, mainly due to larger downward adjustments in energy prices and reduction in volatile food prices. However, inflation is expected to turn positive, thereafter, and gradually align with the targeted level of 5 per cent over the medium term, aided by appropriate policy measures.
The banking regulator said that headline inflation, as measured by the Y-o-Y change in the Colombo Consumer Price Index (CCPI) remained in the negative territory for the third consecutive month, recording a deflation of 2.1 per cent in November 2024, compared to the deflation of 0.8 per cent in October 2024.
Non-Food inflation (Y-o-Y) decelerated further to -3.3 per cent in November 2024 from -1.6 per cent in October 2024. Meanwhile, Food inflation (Y-o-Y) decelerated to 0.6 per cent in November 2024 from 1.0 per cent October 2024.
“On a month-on-month basis, the CCPI recorded a decline of 0.25 per cent in November 2024 due to a 0.02 per cent reduction in the prices of items in the Food category and a 0.23 per cent reduction in the prices of items in the Non-Food category. Meanwhile, core inflation (Y-o-Y), which reflects the underlying inflation trends in the economy, moderated further to 2.7 per cent in November 2024 from 3.0 per cent in October 2024,” the statement added.
In the Japanese example of deflation (most countries impacted by deflation follow Japan’s crisis), that country experienced a period of economic stagnation and price deflation known as ‘Japan’s Lost Decade’ from 1991 through 2002. Since the mid-1990s, Japan has experienced a state of mild deflation, with the Japanese CPI being almost always slightly negative since 1998. Japan had been struggling with deflation for a decade and a half, according to one web explanation of Japan’s experience with deflation.
According to price trends in September in Sri Lanka, samba sold at Rs.229 per kg compared to Rs.230 a year ago, beans fell sharply to Rs.275 from Rs.625 a year ago, local red onions fell to Rs.314 from Rs.346 a year ago. Accordingly, all food prices had come down. However, ask any housewife, working mother or male shopper and they would find it hard to believe that prices have come down. “What the economists say is not real. Food prices are still high,” a working mother grumbled.
Ending the discussion on food prices and deflation, I sipped my second mug of tea, reflecting on the ever-increasing problems encountered by the new regime just a few weeks after being elected!
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