Smoke and numbers: DNA 23rd March 2009

Wholesale Price Index (WPI) inflation has come down to less than half a per cent, and next week it could be even lower or negative. Hurrah! Inflation has been conquered finally and the talk doing the rounds is that there is deflation today as prices are falling. This should bring a smile to your lips, but instead there is a grimace when you go to the market place as your grocery bags get lighter.What is the true picture?The word deflation now dominates our vision and pre-empts our ears especially so as people are talking of a recession. There is evidently a conceptual issue here. Deflation is a concept when all or most prices are crashing and not when some prices are falling, which is the case today. What are we trying to say here? Basically, the inflation rate that is flashed at noon time on all working Thursdays is the WPI which compares the index number with that exactly 52 weeks back, which is a point to point comparison. The WPI consists of a large number of products which have been assigned weights based on their importance. Intuitively you can see that if one set of products with a good enough weights registers a fall, then the index will reflect the same. The question you need to ask is whether these products with declining prices are really pertinent to you.The products that are falling or are rising moderately are transport equipment, metals, rubber, chemicals, minerals and fibres which you and I do not encounter in our lives. Fuel is the only product which affects our lives which is declining. The ones which affect us such as food and textile items are rising. Therefore, we face this contradiction in the market place.WPI is actually reflective of producer prices and does not talk of consumer prices, for which there are different indices called the Consumer Price Indices (CPI). The CPI comes in different variants as it captures the consumption baskets of different kinds of workers. If you are an industrial worker, the CPI inflation would be 10.4 per cent (up to January) while it would be 11.6 per cent if you are a farm worker. The former is used in all organised settings where dearness allowance is marked against prices. These indices give a weight of over 50 per cent to food items and also include transport and rent which does not enter the WPI basket.However, it has become a tradition today for us to fall back on the WPI because it is weekly as against CPI which is monthly. This number is used for all policy formulation, which is why it is tracked quite assiduously. The Budget talks about it and so does the RBI. Governments talk about this number because it is almost always lower than the CPI, and hence is a more convenient number. In the west, inflation is always related to the CPI and never producer prices.So, what are the takeaways from this understanding of inflation or deflation? The first is that we are not in a state of deflation, andthe use of this term is iced more with hype and propaganda. If you are a producer, you are confronting lower prices which are good as it helps to enhance sales, profits which will please the shareholders. If you are a consumer; you should not really feel elated by these rosy numbers as the harsh reality in the market place is different.As a policy framer, like the RBI lower WPI inflation means that it is time to lower interest rates, which they are relentlessly trying to do. The concept of real interest rate comes in here which is defined as interest rate minus inflation. If inflation is close to zero, then the nominal or absolute rate must come down to maintain constant real rates. Hence, if inflation is 8 per cent and the lending rate say 12 per cent, the real lending rate would be 4 per cent. Now, with inflation being at zero, the lending rate must come down towards 4 per cent!Therefore, borrowers are to be encouraged with lower lending rates and industry is savouring this thought. Notice how banksare luring customers with attractive home schemes where coincidentally for other reasons, property prices are on the decline.But, the same also means that the saver, especially those dependentonfixed income as well asretired folks will fume because lower deposit rates on grounds of low real interest rates is 'rubbish' to them as they are still paying higher prices in the market for their daily purchases with their incomebeing eroded. Politicians, it is said, always have the last word, and this negative number comes at a time when the economy is putting up a mediocre performance. The common man does not understand GDP or financial crisis, but knows prices. Negative inflation or deflation -- call it what you may, is a potential winner on the pulpit, which will ultimately matter.