Tuesday, June 23, 2009

Negative inflation in India in perspective

The annual WPI-based inflation India has fallen into negative terrritory for the first time in over three decades last week, reporting at minus 1.61% for the week ended June 6, 2009. The base effect from the corresponding period last year, when prices were on their way up, and relative declines in fuel and power prices, and and not any deflationary trap, is being held responsible for this trend.

The drop in aggregate prices conceals large variations within categories. Primary Articles group inflation increased to 5.8%, up from 5.7% last week, whereas "food articles" inflation remained at a high 8.7%, with cereals, pulses, vegetables, milk and spices recording a high rate of inflation. The price rise translated into retail prices is much higher, as indicated by the graphic of food prices from the Price Monitoring Cell of the Department of Consumer Affairs.

The sharp variations in foodgrain and energy prices apart, the prices of manufactured goods, a more accurate reflection of the underlying prices trends (core inflation), have been remarkably benign, remaining at very modest, even stagnant, levels for months now. As the Financial Express notes, "the weak demand for manufactured products has even caused a free fall in prices of important investment goods like machinery and intermediate products like chemicals in the last few weeks... The revival of demand across the broad industrial spectrum calls for the supply of credit at reasonable cost, something that the monetary authorities have chosen to ignore for too long, but cannot afford to anymore, given that inflation is certainly less of an issue, and that firm recovery remains elusive."

A more definitive indication of the global trend of declining inflation, even for food items, is captured in the graphic below. As compared to the high food price inflation in the year ended February 2009, the price changes for the last three months have been relatively modest, even negative.

As has been argued in earlier posts here, here, and here, the sharp disconnect between the WPI inflation levels and the price rise seen at the retail level is a measure of the distortions and market imperfections, especially at the downstream side, in the market for each of the commodities.

Update 1
WPI comprises three major groups, namely primary articles, manufactured items, and fuel, light, power and lubricants, contributing 22.02%, 63.75% and 14.23%, respectively to overall inflation. See this article on proposals to change over to a monthly WPI with 2004-05 base year and a larger basket of items with different weights.

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