There's a new twist to the inflation story in India. According to the government inflation, India's most feared challenge will be replaced by deflation. As an article in Livemint pointed out, chief economic adviser Arvind Subramanian has reportedly expressed his fear of India being in or close to deflation territory. This is unusual as India has been hobbled by high inflation for decades. Let's have a look on what has happened.
The main issue seems to be the sharp divergence in WPI and CPI indices. While the WPI indicates falling prices, the CPI indicates rising prices. The gap between these two measures of inflation has widened recently. Policy makers are not sure which one to follow. This has stirred up more questions rather than giving clear answers.
The Wholesale Price Index (WPI) decreased for the first time in November in 2014. It has been negative every month since then. By and large, the fall has been accelerating and the index in May 2015 was 4.1% below than a year earlier. One of the many reasons behind this is the sharp fall in the prices of crude oil which has 9% weightage in the index. The other factor is the slowdown in the Chinese economy. This has brought down import prices of various commodities.
On the other hand, the pace of the pass-through to retail inflation has been slow and the magnitude less than desired. The Consumer Price Index (CPI) still points to inflation rate of 3.8%. The Reserve Bank of India (RBI) has stated that the CPI could rise in the coming months.
It is clear that the CPI which is the more accurate measure of the two suggests that inflation in India is not dead. The difference in views between the RBI and the government can be explained by the fact that deflation would imply lower interest rates. The government would find this desirable. On the contrary, the RBI correctly continues to stick to its CPI inflation targets.
The government would like the economy to boom. Cheaper credit would certainly help speed up the process. It has been trying to influence the RBI to bring down interest rates more aggressively. However, the Reserve Bank has not given any impression to do so. We believe the RBI is right to focus on the CPI. It is not only the measure used by central banks all over the world it also reflects the level of inflation that the common man experiences.