It is clear that the media loves something that appears new and exciting— and now it is all about deflation. What will happen if there is deflation? the press asks apprehensively, probably thinking in terms of an automobile tyre with all the air gone—how will the economy move? A lot of TV time is being spent on it saying that we have never faced it before.
The government reports the Wholesale Price Index (WPI) figures every week on a Thursday, giving a lot of grist to the media mill for the weekend. There is a lag of two weeks, that is, the figures are two weeks old. We are among the very few countries that engage in this self-flagellation weekly, for other countries have monthly or quarterly figures. A set of 435 commodities and their price changes are used for the calculation.The measure is that of the average rate of change in the prices of a set of commodities in the wholesale market. A weekly figure that is larger than the previous week indicates that the rate of price increases have gone up over the previous week; a lower figure would indicate that the rate of price increases is lower than the earlier week. Throughout 2007 and 2008, we had the phenomenon that the WPI weekly figures reported were higher than the earlier weeks’—that is, the rate of price increases was climbing. Sharp action by the Reserve Bank of India (RBI) to tighten credit, such as increasing the cash reserve ratio and repo rates, followed to reduce liquidity in the system so that prices did not chase scarce goods. There were a few who realized that WPI prices had strong weightings for commodities, and commodity prices were going up all over the world, and therefore the WPI effect was inevitable. RBI’s intervention could do little about this. Of course, keeping a close watch on credit at a time when asset values were getting artificially inflated was a good thing in itself, for it helped rein in speculation.
The cumulative effect was a week-on-week increase, and that can be captured only by a year-to-year WPI figure. The graph for inflation from 1984 reflects that we have broadly been on a trend line of under 5% yearly inflation—and this suddenly increased in 2007 and early 2008; hence the cause for worry.
The Consumer Price Index (CPI) is a separate story altogether: the government puts out several different figures —for industrial workers, for urban non-manual workers, agricultural labourers and rural labour—and we haven’t been able to sort all this out into a single figure in 60 years, after several statistical commissions. The CPI is much more comprehensive and catches inflationary trends from the consumer’s point of view. Most countries consider the CPI as the true measure of inflationary trends in the economy, but we, just to be different, use the WPI.
The WPI, measured on a weekly basis, rose steadily from 3.79% in January 2008 to a high of 12.63% on 9 August 2008 and declined thereafter, and was 0.27% on 14 March. It is important to remember that prices are cumulatively around 15% higher than in January 2008. The worry of the media is why they are not going up any more. At the same time, the CPI is 10% more than a year ago, which means that the prices in consumer terms are still climbing at 10%.
Finally, when inflation was hovering at around 12%, the prime lending rates were around 9%, a negative real rate of interest, and now, when inflation is 0.27%, the repo rates are still around 4%, so credit in real terms is costlier than last year.
As prices of internationally traded commodities fall, it is to be expected that WPI indices will reflect these decreases. At the same time, high support prices for rice and wheat would continue to keep food prices high. Cotton has been procured at high prices, and textile mills would find it difficult to pay these prices, for yarn and woven cloth prices have not gone up. There is no let-up in consumer goods, soaps, toothpaste and shampoos, nor is there any significant downturn in TVs and white goods, especially in tier-II and tier-III cities. Construction steel prices remain firm, as also cement, since there is a lot of infrastructure and residential housing construction still going on. It is true that paper, chemicals and textiles have had to reduce prices, but sales have not yet fallen. The economy is still growing at a healthy rate of at least 6% and the volatility in financial markets is much less. There is worry about the high borrowings of the government, but there are attempts to fix this along with RBI.
To talk of a deflation or a recession in the economy is therefore quite misplaced. In fact, a lowering of price expectations is likely to lead to growth in consumption demand, exactly what the economy needs at this stage. Perhaps this is a good time to think whether the weekly WPI is indeed a good measure of what is happening in the economy. Also, to realize that a lot of the ills of today are of our own making, not of the global slowdown.
S. Narayan is a former finance secretary and economic adviser to the prime minister. Comments are welcome at firstname.lastname@example.org