Why inflation is still not dead: Financial Express:2nd March 2009

A lot has been made of inflation coming down to an all time low, and all economists and statisticians are quick to add that we may see a negative rate of inflation by March-end. This is naturally so as the WPI for all products is actually falling by 0.5 every week on an average basis, while the base for comparison i.e. last year’s index is increasing by 1.0 every week. And hurrah, there is fear of disinflation now, and its implications are being discussed in various forums. Does this mean that inflation is dead?
Inflation is always a tricky subject because the point to point rate of 3.9% as of February 7 corresponds to an average inflation number of just over 9%. This means that even if we accept the lacunae in the interpretation of the WPI as against the CPI, while prices (or rather the WPI) today appear to be lower than those of last year, we were actually poorer by 9% over the year. This is so because prices had increased during the year before declining, which means that there was substantial erosion in purchasing power during this time period.
However, a negative overall inflation rate does not mean that you and I are witnessing falling prices across the board. It is essential to take a closer look at the structure of inflation by dissecting the WPI as it stands now. Double digit inflation is still seen in around 10% of the WPI constituents. Another 42% of the constituents had an inflation rate of 6.5% where individually each sector had an inflation rate ranging between 4-10%. The 4% cut-off mark is taken to be the ideal rate as defined by the RBI in its credit policy last April. The last category of negative inflation covered product groups that constituted 9% of the WPI.
There are some really interesting points that come from this dissection of the WPI. The first is that while the number that strikes us every Thursday is for all products, it certainly is not indicative of the movement of all prices. Therefore, when people talk of disinflation, it is misleading. Disinflation is where all products are witnessing declining prices. At the moment, there is a fall in only around 10% of the WPI product groups. The second is that for around half of the WPI products, inflation is well above the so called target rate of 4%. The third is that where inflation is negative or low for some groups, these prices have been mainly driven by global factors. Oil prices have fallen sharply by over 70% and the global slowdown has led to the fall in metal prices by over 50% in most cases. Hence, lower inflation here is actually exogenous to the system. The last is that the basic home products, i.e. products that we consume have still seen substantially higher prices this year which should be a concern. Food products, in particular, are up in both the primary and manufactured stages which still make costs of living difficult. As a corollary, the products showing low price increases are basically the industrial goods which do not enter our consumption basket. In fact, they derive their lower value from the fact that they are the final products of the raw metals that are used for their manufacture.
What does all this amount to? Most importantly we must not get carried away by the lower single numbers that we will be seeing over the next 6-7 Thursdays. Let us also ot get into the habit of asking whether we are heading for disinflation. It would be adding hype to an incorrect thought process. Also while the Thursday number does guide market sentiments which in turn mounts pressure on Mint Street to lower interest rates—with the ‘real interest rate’ theory being floated—it does not make our pockets any lighter. This is the real truth.