Prices of manufactured goods are stagnating; interest rates have been cut; government borrowing is spiking to maintain the level of its spending, particularly to ramp up measures to fight the pandemic; Reserve Bank of India has come out with a bouquet of measures this week to push up credit and help banks keep going. Nothing appears to be working.

These days, I was remembering a casual conversation with a lady in Japan more than a decade back, when she was recounting her experience of the Japanese economy those days.

I was visiting Japan and study aspects of the country’s economy and its functioning. Japan looked different from all others in their organisation of things to their typical muted colour schemes. It also gave me opportunity to engage in long conversations with people that you ordinarily do not get.

Even at this distance, I remember a lady talking about the Japanese phenomenon of “deflation”. She was telling me of a horrible sinking feeling. Prices were slowing and inevitably falling and there were no signs of these going up. People keep putting back purchase plans because you expect prices will fall again.

Firms do not invest, because there is not enough incentive to invest and increase production capacity. Employment is static because not many new initiatives being taken.

Monetary authorities keep lowering interest rates hoping to encourage investment and overall demand. When cuts in interest rates hit the rock bottom and monetary instruments are exhausted, only fiscal expansion remains as the last resort. Meanwhile, the government keeps borrowing money to continue to spend and the debt portfolio keeps rising.

An ordinary person was giving me lessons in fundamental economics, I thought. But that was it. They were in the midst of a deflation and people were at a loss.

The thirty-year long deflation in Japan is a classic case in economics. The deflation started around 1990 and continued. Economists have studied it but no more than a handful of Japanese economists have given new insights into the phenomenon.

The Financial Times of London had organised a three-day long deliberations, the Global Boardroom, on a virtual platform, with studios in London, New York, Washington, Tokyo and Singapore, discussing as day proceeded into night across the globe. It was a virtual super-market for ideas and issues. The presenters were world leaders in their subjects.

It was one of the sessions that discussed the Japanese deflation. Professor Hiroshi Yoshikawa, president, Rissho University, is the renowned scholar on Japan’s deflation, the phenomenon also known as Japanification. Professor Yoshikawa differentiated between an assets price deflation and the deflation of the general prices.

He concurred with the Bank for International Settlements study that an assets price deflation was far too dangerous from a general price deflation. When the deflationary cycle began it was primarily a debt deflation and the problem was basically monetary.

Beginning 2000, the debt and monetary problem generally spread to the real economy.

Agreeing with him, Professor Jenny Corbett, project professor at the University of Tokyo, warned that the key to avoiding a prolonged deflationary state was to look for signs of it well in advance.

Here, she marked out assets price bubble as the initial sign of the onset of a deflationary spiral. She suggested at all costs an assets price bubble should be avoided. However, when into it, the corrective process should be very gradual and cautious. Its resolution should be through a “soft landing” rather than a hasty process of correction.

Once an assets bubble bursts, banks get hit and that starts the process of a serious downward spiral. Banks generally call for recapitalisation and only once a thorough study is done, the process of banks rescues process should begin, one has to choose between which ones to be recapitalised and which ones should let go. Some will of course have to be sacrificed, but those found resilient must be well capitalised.

Listening to their analysis of Japanese deflation and its early stages, I found a rather strange parallel with what is happening in the Indian economy now. The Indian stock markets are behaving as if there is no trace of a pandemic and a devastating second wave of infections visiting us. Looks as though an assets bubble is forming.

The prices are soaring without a sense of a link to the real economy. One only hopes that the trades are being funded not with money from banks and the informal non-banking financial companies. In a situation like the present, the sentiment could burst any time under the pressure of what is happening in the real economy.

God forbid, but if there is a crash in the financial assets markets, and if these had funding from banks and NBFCs, the financial institutions would be hit hard. Already, Indian public sector banks are weighed down with non-performing assets. Further addition of bad debts would be a killing burden.

Instead of being liberal, it is time to be fastidious about lending funds for trade finance. RBI has liberalised bank credit for covid support this week. It will be important to ensure that freer funds are not diverted into financial assets markets leading to their price rise to unsustainable levels. The additional RBI accommodation should be used for support to the real economy which is bearing the brunt.

There are several other aspects of that Japanification episode which have some resemblance to our present situation. Slower growth and secular stagnation have been witnessed during that period. We have been seeing these for the last few years.

Nonetheless, one swallow does not make a summer. One or two resemblances should not mean a similar follow up of events. There might be so many other ways that the Indians economy can respond. Hopefully we should turn around shortly. (IPA Service)