Deflation is a real possibility

Takunda Mugaga Economic Agenda
Unemployment and inflation are some of the major headaches for an Government across the world. The common economic understanding that unemployment and inflation are negatively correlated seems to be holding in Zimbabwe with these two major economic indicators heading in different directions.

A number of questions have been raised about what could be causing a steady and continuous decline in inflation when the supply side is in disarray while there is a huge appetite for spending ahead of production, a true haven for demand pull inflation.

By definition, some scholars believe inflation can only be described as such when the general level of prices are increasing significantly, consistently and at a broader scale, which means if within a basket of eight commodities, the price of two products increase that cannot be classified as a case of inflation crisis.

Indeed in the absence of a monetary policy that manages interest rates to moderate inflation only a depressed Government spending pattern can help stem the tide.

Most people have been questioning why prices continue to be high when inflation is going down.

The response is two pronged, inflation decline does not mean prices of commodities will fall rather it is only the rate at which the prices will increase that slows.

However, there are instances when prices are actually falling towards the negative direction which is different from an inflation decline.
Inflation can only be defined as such when the price movement is in the positive territory, the moment the rate fall below zero it becomesdeflation.

Japan is the first nation that comes to mind when deflation is mentioned. Japan’s inflation is approaching -2 percent with interest rates staying put at 0 percent for most of the time.

This has resulted in a change in governments more than 10 times since 1990 mainly due to disgruntlement within industry due to the negative effects of deflation.

In our case our inflation rate was 0,5 percent in October and there are expectations that the rate will decline further as a result of pressure from liquidity challenges in the economy and activity in the informal sector.

The aggregate demand for both consumer and capital goods is approaching an abyss as personal disposable income have declined so significantly, the near absence of consumer finance in banks, a non existing monetary base which makes determining broad money supply difficult, an influx of cheap imports and a dwindling consumer market have all, but created a breeding ground for deflationary pressures.

Traditionally, a stagnant economy is prone to inflationary shocks, but the dollarisation has imposed unsustainable austerity on the part of Government spending, which has dwindled to levels which cannot impact on job creation or consumer spending.

The reality of deflation is quite a disturbing phenomenon for an economy such as ours, which will definitely require incentive for it to peak. With deflation, the incentives to produce will be limited as the profitability gap will be close while operating costs are bound to rise.

This is in spite of the under-valuing of such expenditures towards the consumer basket and the determination of consumer price index.
With deflation demand for real assets also dwindles as they become sub-prime model of keeping assets.

The prices of stocks and other real assets becomes stagnant which will leave those banking institutions who have over-collaterised loans in a quandary as they can no longer rely on the security they are holding against an unimpressive loan book to recoup their assets.

Indeed deflation can become a reality in Zimbabwe next year if the liquidity challenges in the economy, the unsustainable import bill, and burgeoning fiscal deficit as a percentage of GDP are not addressed.

Other African states have the privilege of monetising the deficit which Zimbabweans do not have due to the forced austerity mode we are in.