Friday, June 26, 2009

Deflation Concerns

The annual wholesale price index (WPI) based inflation rate fell to negative in the first week of June 2009, the first time in well over three decades. The last time the inflation turned negative was in late 1974 and early 1975.

Well, though the inflation has become negative, this is not deflation in the true sense of the term. The inflation numbers as released by the department of commerce and industry for the week ending June 6, 2009 is -1.61%. One must keep in mind that this is the Year on Year inflation rate and not inflation rate with respect to the base year.

All this means is that the prices of goods in the WPI basket has decreased by 1.61% with respect to its prices in the corresponding week last year. So if Good A was priced at rupees 100 on June 6 last year, the price of that good this year is 98.39 rupees. So the benchmark index is the price of the good A last year. Simply put, this is what is called base effect. Base year being 2008.

This is severely misleading vis-a-vis purchasing power of the common man. Last year, at this time inflation was hovering in double digits. It was almost 12% (11.66% to be precise). So the prices of the goods in WPI basket was 11.66% higher in 2008 compared to its prices in June 2007. So if one compares the prices in 2007 to the one in 2009, there is a an inflation of +9.8% over two years. (suppose the price of a good A in 2007 was rupees 100, it had become 111.66 in 2008 owning to 11.66% year on year inflation. So if the inflation now in June 2009 has dipped to -1.61 % year on year, the price of good A in 2009 is 109.86 rupees. This means an increase in price of 9.8% compared to 2007) . In other words, inflation is 9.86% with 2007 as base year.

The decline in the year-on-year inflation rate during the reported week this year was primarily due to a dip in the inflation rate of fuel and power that declined because of the base effect.

On this backdrop, if one strips the WPI basket and looks at the food prices, the year on year food inflation rose to 8.7 per cent this year, with cereals, pulses, vegetables, milk and spices recording a high rate of inflation. This is in spite of the fact that inflation rate of power and fuel plunged sharply this year by 12.8% year on year (-12.8%). This is very bad sign. This is giving an indication that though fuel and power prices have declined over the year, the food prices have increased. This is pointing to a bottleneck in the supply of food articles. With not so good monsoons on the cards, the signs are worrisome. The food situation will go from bad to worse by the end of this year or early next year if the monsoons fail. Monsoon failure will plummet the power situation, the inflation numbers of which will start recording positive numbers.

Legislation wise , the food security act contemplated by the UPA chairperson is most welcome here. But Supply of food need to be augmented for this kind of act to bear fruition in the near future.

Hopefully the upcoming budget will put in some fiscal policies to augment the food supply, give financial fillip to renewable energy, augment water conservation programmes and put the right policies for food import.

Returning to the inflation numbers. The food inflation now stands at +8.7% over last year. If one compares this with food inflation last year, we are in for a surprise. Though the inflation was in double digits last year, the food inflation was 5.8% year on year. But in comparison, the year on year inflation based on WPI is negative this year (-1.61%), but still the food inflation stands at +8.7%. This is a very bad signal for the food situation in India .

Coming to inflation over the last two years, let us look at food prices. Inflation over the last two years in food has been 14.5% (Factoring 5.8% in 2008 over 8.7% this year). So the purchasing power of an individual has gone down by 14.5% compared to 2007 so far as food is concerned, assuming the income has remained constant which may not be the case.

But lets see it more carefully, the recent economic recession has had a lot of impact on the employment in the unorganized sector. Towards the end of 2007 national commission for enterprises in unorganized sector headed by Economist Arjun sengupta published some startling results. It said 77% of the people of India (about 835 million people) earn less Rs 20 a day( The economic recession would have worsened this situation. Major share of the earnings by workers in the unorganized sector goes in procuring food. Assuming that each worker was spending 10 rupees on food and 10 rupees in asset building everyday in 2007, he will now have to shell down 11.4 rupees for the same food.

In the light of this analysis, the food security act proposed by UPA assumes greater importance and one hopes that it will meet its desired goals.

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