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Will deflation be the next crisis?
Mon, 27 Jan Pre-Open

Hovering around levels of 1.5%, inflation rates in developed parts of the world have been quite low for a while now. This has been happening despite the occurrence of unabashed money printing. Central banks of the developed parts of the world have been targeting inflation at levels of 2%. But the way inflation numbers have been moving i.e. downwards, meeting the target seems difficult.

In a recent article posted in the Business Standard, the author goes on to point out the possible reasons for such an occurrence. These include rising productivity, over capacities being built up or favourable import costs. He also mentions that going by the way the price of sensitive items - those of metals, export import prices in the US, local manufacturing prices - have been moving, all signs point towards downward pricing pressures in the developed parts of the world. And that this is why these countries could be staring at a possible deflationary environment!

Deflation is seen as a threat in a post bubble environment. Especially when one has a large sum of debt sitting on one's head. The debt, which is borrowed at a fixed rate, needs to be repaid. And as author points out, deflation leads to a rise in real debt levels and hence affects repayment capacity. And this could eventually result in bankruptcies. Given the debt situation of the developed economies, it does paint a scary picture.

As the author points out, reduction in discretionary spending and thereby consumption would be the obvious effects if such an outcome was to arise. And these in turn would impact the overall hopes of a bounce back in growth levels, thereby making economies rely on the support of their respective central banks for even longer.

While the outcome presented by the author is probable, this scenario is just one of the many that are likely to play out. We believe investors would do well not to pay too much attention to scenarios that are nearly impossible to predict. However, it would be good to prepare for the worst. And by sticking to the bottom up stock picking approach and investing in quality businesses, we believe investors would be doing just that.

For information on how to pick stocks that have the potential to deliver big returns, download our special report now!

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