About Low Inflation and Its Economic Impact

Recent data from 2025 shows inflation in India at a historic low. The Consumer Price Index (CPI) for October registered just 0.25%, signalling a near price stagnation compared to the previous year. More strikingly, if gold prices are excluded, inflation turns negative. This situation has raised concerns among economists and policymakers. Low inflation affects growth, wages, tax revenues and farmer incomes. It also reflects weak demand in the economy, which could slow production and lead to recession risks.

Current Inflation Scenario

Inflation is measured by the Consumer Price Index, which tracks price changes in a basket of goods and services. Gold, classified under personal care and effects, inflates the CPI due to its rising prices. However, gold is an asset, not a consumable good, and inflating CPI with gold prices distorts the true inflation picture. Excluding gold, CPI shows a 0.57% price decline year-on-year. Food and beverages have also seen deflation, with vegetables down 27.57% and pulses 16.15%. Overproduction and poor demand have caused unsold crops to rot in some regions.

Implications for Farmers and Agriculture

Agricultural deflation hurts farmers’ incomes directly. Despite protests against farm laws, which aimed to stabilise prices and supply chains, persistent demand-supply mismatches continue. The current price drops show the ongoing structural challenges in Indian agriculture. Farmers face distress as excess produce fails to find markets, leading to wastage and income loss.

Impact on Firms and Employment

Low inflation signals weak consumer demand. Firms respond by cutting back production, which reduces wage growth or leads to layoffs. This creates a vicious cycle – lower wages reduce spending power, further weakening demand. Such conditions can push the economy towards recession. Therefore, moderate inflation is essential to keep firms motivated to produce and hire.

Government Revenue and Fiscal Health

Government tax revenues depend on nominal GDP, which combines real growth and inflation. When inflation falls below expectations, tax collections drop, worsening budget deficits. India’s deficit concerns are heightened by recent tax cuts and GST reductions. Low inflation thus strains fiscal resources and limits government spending capacity.

Inflation Targeting by the Reserve Bank of India

India’s inflation target is 4% with a tolerance band of 2% to 6%. Falling below 2% triggers concerns for the Reserve Bank of India (RBI). Persistent low inflation may prompt RBI to cut interest rates to stimulate demand. While low inflation benefits consumers by increasing purchasing power, it poses risks to overall economic stability.

Effects on Savings and Investments

Lower inflation means lower interest rates on fixed deposits and other savings instruments. Savers must adjust expectations for returns. Equity investors should recalibrate long-term growth assumptions. Retirement planning requires continued equity exposure to outpace inflation, even if inflation remains low.

Future Outlook

SBI research forecasts inflation could remain negative for the next two months excluding gold. RBI’s inflation estimate for 2025-26 has been revised downward to 2.6%. The economy faces a delicate balancing act – encouraging demand without letting inflation rise excessively. Policymakers must navigate this to sustain growth and financial stability.

Questions for UPSC:

1. Point out the causes and economic consequences of deflation in agricultural commodities in India.
2. Critically analyse the role of the Reserve Bank of India’s inflation targeting framework in stabilising the Indian economy.
3. Estimate the impact of low inflation on government fiscal deficit and public expenditure in emerging economies.
4. Underline the relationship between inflation, wage growth, and employment generation with suitable examples from developing countries.

Answer Hints:

1. Point out the causes and economic consequences of deflation in agricultural commodities in India.

1. Causes include overproduction and weak demand leading to excess supply of crops like vegetables and pulses.
2. Structural issues in Indian agriculture such as poor supply chain, lack of storage, and market inefficiencies exacerbate price falls.
3. Deflation reduces farmer incomes, causing distress and financial instability in rural areas.
4. Unsold produce leads to wastage (rotting crops), increasing economic loss and food security concerns.
5. Farmer protests against farm laws reflect demand-supply mismatches but reforms were aimed at stabilising prices.
6. Overall agricultural deflation can depress rural consumption, affecting the broader economy.

2. Critically analyse the role of the Reserve Bank of India’s inflation targeting framework in stabilising the Indian economy.

1. RBI targets 4% inflation with a tolerance band of 2%-6% to balance growth and price stability.
2. Inflation targeting helps anchor inflation expectations, providing policy predictability for markets and households.
3. Low inflation below 2% signals weak demand, prompting RBI to consider rate cuts to stimulate growth.
4. Framework aligns monetary policy with economic goals, but rigid targets may limit flexibility in shocks.
5. Excluding volatile items like gold from CPI can give a clearer inflation picture for policy decisions.
6. Overall, RBI’s framework supports stable inflation but must adapt to structural and external challenges.

3. Estimate the impact of low inflation on government fiscal deficit and public expenditure in emerging economies.

1. Low inflation reduces nominal GDP growth, leading to lower tax revenues than projected.
2. Declining tax collections widen fiscal deficits, limiting government spending capacity.
3. Emerging economies often rely on indirect taxes linked to nominal values, so low inflation hits revenues harder.
4. Fiscal deficits under pressure may force cuts in public expenditure or increased borrowing.
5. Lower inflation can benefit consumers but strains public finances, affecting social programs and infrastructure investment.
6. Governments may need to revise budgets and fiscal targets in response to persistent low inflation.

4. Underline the relationship between inflation, wage growth, and employment generation with suitable examples from developing countries.

1. Moderate inflation signals healthy demand, encouraging firms to increase production and hire more workers.
2. Low inflation or deflation indicates weak demand, leading firms to cut output and slow wage growth or reduce employment.
3. Wage stagnation reduces consumer spending, creating a negative feedback loop that dampens economic growth.
4. Example – India’s current low inflation correlates with concerns over wage pressures and employment generation.
5. Developing countries often face informal labor markets where wage adjustments lag inflation trends.
6. Balanced inflation supports job creation and real wage increases, crucial for poverty reduction and economic development.