By Arunima Chakrabarty
In August, Indias wholesale inflation rate continued its downward slide, for the tenth consecutive month. The Wholesale Price Index fell by 4.1% on a year-on-year terms in July 2015[1], the steepest decline recorded since the official monthly series began in 1982. This is unprecedented in a country where decline in price indices are extremely rare in recent times. What does this mean for the Indian economy? Are we falling into a vicious deflationary trap? Is India following the footsteps of Japan? Is the situation really worse?
While the WPI continues to slide, economists are confident that India is nowhere close to the kind of deflationary spiral that has hobbled the economies of certain developed nations. Instead, what India is experiencing is much closer to disinflation, which is a welcome development in a country that has witnessed years of high prices. While deflation refers to negative inflation, a fall in prices; disinflation means a reduction in the rate of inflation. But isnt it true that prices are falling in India? Yes, they are. At this point its imperative that we split the WPI basket into two halves, and analyse them independently in order to understand why its disinflation and not deflation.
Let the first half denote input prices (raw materials, intermediary goods etc.) and the second half denote output prices, capturing the price of final products. A closer look at the data tells us that falling input prices are the main reason behind the decline in WPI. This includes lower prices of commodities such as metals, oil, rubber, minerals, and chemicals etc., all of which are raw materials for the industrial sector. This fall is being led by plunging oil and manufactured goods prices. Not surprisingly, the largest share of this decline was bagged by fuel and power, which contracted 12.8% in year-on-year terms and recorded a 2% fall from June 2015. Meanwhile, manufactured goods recorded a 0.3% decline in month-on-month terms (from June to July). On the other hand, output prices have not dipped drastically, and in most sectors they have continued to rise, albeit at a slower pace. This is further strengthened by the fact that CPI based inflation (retail inflation) continues to be positive and so are inflation expectations.
Input costs in the transport equipment (auto) sector, tobacco, beverages and food products have fallen sharply. However, the output prices in these sectors havent fallen. This gap between input and output costs is actually a good sign for the economy, as it indicates that profit margins will rise. The gap between CPI and WPI inflation has been widening, this augurs well for profitability and should be reflected in companies balance sheets in the coming quarter.
However, some sectors havent benefitted from the lowering input costs – such as the paper and cement industries – probably due to weak demand. Yet, we can confidently state that the low WPI brings more good news than bad. Lower commodity prices are a positive terms of trade shock for India. Terms of trade (TOT) is the ratio of a countrys export prices to its import prices; it can be interpreted as the amount of goods a country can import per unit of export. A fall in commodity prices will help India in reducing its import bills. This might be dampened by the weakening of the rupee, but the overall effect will mostly remain positive.
Its safe to conclude that while the negative WPI may have some negative effects on the economy, it is not a cause for worry. Surprisingly, the net effect for the Indian economy may be positive due to the low commodity prices, and the expectations of higher profit margins. Deflation, for now at least, isnt one of Indias problems.
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The author is a final year student of Economics at Miranda House, University of Delhi