Inflation: High Base Effect Leading To Low Levels

Inflation numbers which had hit record highs in Aug-Sept’08 on the back of record high commodity prices has declined and touched all time lows of 0.27% for the week ending 14th March’09. This spectacular fall in the numbers is the reflection of the steep fall in the commodity prices. This extra ordinary circumstance has led to Inflation numbers falling to the near zero percent levels and probably turn negative in the course of the next few months on account of the base effect. The Inflation numbers is calculated on a year on year basis. (Current year WPI number / last years WPI number for the same week). Last year the WPI index had seen a huge rise on the back of the commodities rally and then witnessed a steep correction as commodity prices corrected. Hence this low inflation numbers is merely a reflection of the events that took place in the last 1 year. The negative inflation does not indicate that the economy is going into deflation. It is just a statistical effect.

Globally commodity prices had shot up to touch record highs in June’08 resulting in inflation numbers touching record highs both domestically and globally. Energy prices had gone up by nearly 50% while metals and agricultural prices had gone up by around 30%. Domestically, the impact of the high global prices was also felt with prices in the WPI index witnessing huge upward revision. Post the global financial crisis, prices of commodities witnessed a spectacular fall as moderating economic growth was not conducive for high commodity prices. Energy prices have fallen by nearly 70% from their peak while metals have corrected by nearly 50%. Globally agricultural prices too have seen a correction by nearly 40% from their peak. This has resulted in a steep fall in inflation numbers globally. It has also had a positive impact on the domestic inflation numbers which is represented by the Wholesale Price Index (WPI Index). The WPI index is made up of three major constituents. i.e. Primary Articles Index with a weightage of 22.03%, Fuel, Power, Light and Lubricants Index with a weightage of 14.23% and the Manufacturing Index which has a weightage of 63.74%.

Since touching its peak in the first week of September’08, the WPI index has fallen by 5.97%. The Manufacturing index which has the highest weightage has fallen only by 4% while the Primary articles index has fallen by 2.46%. The fuel index has witnessed the maximum fall of 14.47%. It is steep fall in the Fuel index that has contributed significantly to the fall in the Inflation numbers. The reason for the fall in the fuel index is the steep fall in crude prices which has corrected from the USD 147 per barrel levels to USD 50 per barrel levels. The fall in the manufacturing index is mainly on account of a fall in the global commodity prices and the impact of the duty cuts that the government has initiated. The primary articles index has fallen the least despite the fall in the global agricultural prices. The main reason is that in India, the government announces a Minimum support price (MSP) i.e. the price at which the government will buy from farmers. Despite good crop production in the last 2 years, the prices of food grains have not fallen since the Government has increased the MSP for agricultural products which is reflecting in the higher growth in the primary articles index.

Going ahead, in the next few weeks, we might see the Inflation numbers turn negative for the first time. However this negative numbers should not be constituted as deflation sine deflation occurs primarily when the economy is in recession and the prices of goods are falling due to lack of demand. However in case of the economy, the GDP growth is projected to slow down but still grow around 5.5%-6% as compared to the developed economies wherein the GDP is actually shrinking with falling inflation numbers. This negative inflation is only a reflection of the phenomenal rise and the equally spectacular fall in the commodity prices in the last 1 year which impacted the prices of goods.