India Stares at Deflation, Inequality, and the Demand Squeeze
Prime Minister Narendra Modi chaired a meeting to discuss the roadmap for Next-Generation Reforms! (Image Narendra Modi, X)
Low prices are not always a blessing; below a certain point, they are an early warning of economic slowdown
By SAHASRANSHU DASH
KATHMANDU, August 20, 2025 — On August 12, 2025, the Ministry of Statistics and Programme Implementation (MOSPI) reported that retail headline inflation for July had fallen to an eight-year low of 1.55 percent, dipping below the Reserve Bank of India’s target band of 2–6 percent. This marked a 55 basis-point decline from June. Food inflation turned negative: the Consumer Food Price Index (CFPI) recorded –1.76 percent year-on-year, with rural areas at –1.74 percent and urban areas at –1.90 percent.
Compared to June, this represented a further 75 basis-point drop, making July’s numbers the lowest since January 2019. The decline was driven by a favourable base effect and falling prices in pulses, cereals, vegetables, sugar, confectionery, eggs, and even transport and communication services.
At first glance, low inflation may seem beneficial—cheaper prices help consumers—but the reality is more complex. Deflation compresses farm gate prices, reduces rural incomes, and dampens village consumption, hurting demand for tractors, fertilizers, two-wheelers, and staples. Agriculture still employs 43.51 percent of India’s workforce (ILO estimates), contributing around 16–17 percent of GDP.
A prolonged phase of falling food prices threatens rural livelihoods and the broader economy. If the trend persists, minimum support price hikes or targeted rural stimulus may become necessary, even amid constrained fiscal space.
Urban India faces its own pressures. Weak wage growth, stagnating incomes, and rising inequality are slowing consumption in cities, affecting retail, services, and real estate sectors. Household spending by the urban middle class has stagnated, while the top 10 percent captures a disproportionate share of income growth.
This dual slowdown—rural deflation and urban stagnation—challenges the narrative that India’s consumption story alone can sustain GDP growth. Demand for cars, electronics, consumer durables, and even discretionary services is muted, and small and medium enterprises dependent on local consumption face a squeeze.
External trade pressures compound these challenges. The United States has pressed India to open its agricultural sector to imports, raising fears that subsidized US food products could undermine domestic farmers. With five multinational corporations controlling over 90 percent of global food trade, any reduction in protections exposes Indian farmers to predatory pricing, threatening the livelihoods of millions.
Agriculture is not just an industry but the primary source of income for over 700 million people, making the political economy of food highly sensitive.
India’s export growth is also under strain from rising US tariffs—some as high as 50 percent, with even higher tariffs being threatened—on textiles, electronics, and other manufactured goods. Analysts estimate this could reduce GDP growth by 0.3–0.8 percentage points.
Even a 0.5-point reduction would be significant for an economy aiming to maintain 6–7 percent growth (and aspiring to 8 percent, in order to best leverage its demographic dividend). Sectors such as apparel, leather goods, and mobile phones, which employ millions, are especially vulnerable, while smaller exporters struggle to absorb the added costs.
Structural reforms offer a key policy lever. The proposed GST overhaul collapses four tax slabs into two—5 percent and 18 percent—eliminating the 12 and 28 percent brackets. Lowering prices across a wide array of goods could boost GDP by 0.6–0.8 percentage points through stronger domestic consumption.
It also streamlines compliance for exporters, reduces refund delays, and eases working-capital constraints, providing some protection against global protectionism.
Yet consumption alone cannot sustain growth. Low inflation raises real interest rates, tightening monetary conditions and discouraging borrowing and investment.
The RBI’s inflation target band exists to prevent stagnation; the 2 percent floor is designed to avoid the cycle of weak demand India now risks. So, inflation is now 45 basis points below the domestic economy’s comfort zone.
Such persistently low inflation erodes incentives to spend, fosters expectations of further price declines, and limits central bank flexibility. Nominal interest rates approach zero if inflation remains subdued, leaving little room for monetary stimulus.
In this context, inflation that is “too low” can be just as damaging as inflation that is too high.
Monetary policy must act in tandem with fiscal measures. Reducing policy rates would lower borrowing costs, unlock stalled projects in manufacturing, autos, and electronics, and ease corporate debt burdens. This could convert the GST-driven consumption boost into durable, investment-led growth rather than a temporary uptick.
The Monetary Policy Committee projected FY2025-26 inflation at 3.1 percent and held the repo rate at 5.5 percent on the 6th of August, balancing rate cuts, credibility, and tariff risks. Yet now we know that inflation is precisely half that, with potential to fall further. The central bank’s caution may unintentionally entrench real interest rates too high for an economy struggling with weak investment and fragile rural and urban demand.
Public capital expenditure has already been deployed aggressively. By early FY2025-26, 20 percent of the Rs 11.4 lakh crore capex budget had been utilized in just two months, compared with 13 percent last year. Much of this flows into infrastructure—roads, railways, and energy—creating jobs and capacity. But public capex alone cannot sustain growth.
India’s investment-to-GDP ratio was just 30.5 percent in Q3 FY2024-25, a three-year low, far below the 40-plus percent ratio needed for rapid expansion. Despite NITI Aayog’s initiatives and GST reforms, the private sector remains cautious. Private equity and venture capital investments fell 10 percent year-on-year to $16.8 billion (excluding real estate, which is treated separately due to its distinct investment cycle).
The deflationary trend also affects interlinked sectors. For instance, falling rural incomes reduce demand for tractors, irrigation equipment, fertilizers, and food-processing machinery, while urban wage stagnation limits demand for two-wheelers, consumer electronics, and retail services. Even the hospitality and entertainment sectors face softer demand, underscoring that consumption weakness is broad-based, not confined to a single segment.
The solution lies in a balanced strategy. GST reforms can spur consumption. Monetary easing can reduce borrowing costs and restore confidence, encouraging private investment. Public capex can lay foundations but cannot remain the sole engine of growth. Coordinating these strands—stimulating demand, enabling investment, and protecting rural livelihoods—can help India withstand deflationary pressures and external shocks.
Low prices are not always a blessing; below a certain point, they are an early warning of economic slowdown. Without careful coordination of tax policy, monetary easing, and private sector revival, the economy risks a cycle of weak demand, fragile investment, and rural-urban distress.
(This is an opinion piece, and views expressed are those of the author only)
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