Home » Business » Is Deflation a Bigger Devil? [opinion]

Figures released last week showed that the country recorded negative annual inflation rate of 0,91 percent for the month of March. This is the second consecutive month that inflation has fallen into negative, with February annual rate of inflation at negative 0,49 percent.

Essentially, a deflationary trend has just developed, if it sustains then the country could fall into full blown deflation. Going down memory lane, six years and back, the country’s inflation was another story. Hyperinflation was at its peak and recorded as one of the highest in the world history. Effects of the period are still vivid in people’s minds, and the common man might actually rejoice at the news that inflation has hit negative. However, deflation is a monster in its own right and when compared with hyperinflation, could be just another side of the same coin. Worse still, could deflation actually be a bigger devil?

Simply defined, deflation is a decrease in the general price level of goods and services and occurs when inflation rate falls below 0 percent.

Initially, the country’s inflation fell into negative a few months just after dollarisation, recording negative 7,7 percent in December 2009, being the highest deflation rate since dollarisation.

Understandably, the circulation of foreign currency was still low as the economy was still adjusting to a new monetary system.

With time, inflation managed to break through into positive in March 2010, peaking at 6 percent in May 2010, and kept an upward momentum until around March 2013. From then on, inflation has been on a down trend and by late last year there were fears that the country was slowly breaking into deflation.

Year on year negative inflation rates for February and March confirmed those fears and additionally fundamentals on the ground are suggesting that the rate might continue trending southwards.

Considering that our inflation was once positive, the question is how did we get into the predicament of deflation? The main reason attributed to this has been that of weakening demand.

Various reports have indicated that companies were either closing shop or downsizing as the harsh economic environment is making it difficult for businesses to stay afloat. With an increase in the number of people losing the jobs, naturally the aggregate income would narrow.

Amid that, consumers have been forced to scale down on their spending. This, in turn, has gone back to harm the companies through declined sales volumes and therefore lower revenues. Delta is a most recent case to have cautioned the market that they are expecting a 1 percent decline in revenue for their financial year to March 2014 owing to depressed sales volumes in most of their key beverage lines.

The first quarter of 2014 witnessed the greatest decline in volumes compared to the other periods of their financial year, which concurs with the inflation statistics for February and March of this year.

Seemingly, hyperinflation is just the opposite side of deflation, where prices are increasing much faster than the level of production. Generally production is highly constraint and supply into the market is way lower than demand.

As a result, exports also decrease to very low levels and this causes a shortage of foreign currency. Periods just before dollarisation, hyperinflation was so rife that money was losing value by the day.

Shops were empty, and consumers were unable to satisfy their demand as there was no supply.

Assets lost value, and pension schemes that constituted a lifetime of savings were completely wiped out.

It was tragic for those that were on retirement as they could not receive any meaningful pension payouts.

In addition, the central bank had to continually print money, an act which has mainly been blamed for fuelling inflation in the first place. Rebasing currency was also the order of the day. For many, hyperinflation is a nightmare they do want wish to re-live.

Given such a horrific experience, and comparing hyperinflation with deflation, would deflation not be a better devil, given the two? For many, it is the general fear of shortages of basic commodities that would make them relatively comfortable in the present scenario.

However this is a myopic view and the long term effect of lower demand is more companies folding up because they are not able to generate optimal revenues enough to be profitable. In this US dollar economy, continuous losses cannot go on without repercussions.

In the long term, the economy falls into recession, and most of the features of hyperinflation also knock in as well.

On overall, given the effects of both deflation and hyperinflation, both positions are undesirable. Central bank authorities across the world have usually agreed on a range of between 2 percent and 6 percent as an inflation rate target.

Of course, economic situations differ among countries, but having a benchmark such as this one helps in giving pointers of when a Government ought to act to prevent a swing into either deflation or excessive inflation.

Layman’s perspective on deflation is that it is a preferred predicament to hyperinflation.

This is however a short term view as it fails to look at the bigger picture.

The problems that deflation presents to industries of a country, are big enough to threaten the closure of the same. This just streams down to the consumer through lower disposable income and therefore tightened spending than before. At the same time hyperinflation is no cocktail either.

The rate at which assets lose value is alarming and producers, especially those that import raw materials, are faced with serious bottlenecks in production. Therefore, any country should have a target inflation rate that is optimal for economic development.

In the case of Zimbabwe, to be able to push its inflation level to that point, it requires a stimulus through liquidity injection, to revamp business activity and induce spending again.

Considering that Government is not in a position to provide bailout packages, an inflow of foreign capital will therefore be necessary to awaken companies from their slumber.

Otherwise, deflationary pressures might continue and push the economy into recession.

Source : The Herald