The low inflation scenario in India has neither created enthusiasm in the corporate sector nor has it increased the consumption propensity in the household sector. Is low inflation leading India to a deflationary situation?

An ardent follower of the economic data published by the Central Government will be glad to note that the inflation levels are hovering around one to two percent. Since the last couple of years the inflation rates are significantly low and since January 2002, they have slipped below the two percent level. What does this mean to India Inc.? Are these rates reflecting a true picture of the state of the economy? What about the issue of high real interest rates when compared to other countries? Is this an indication of the economy moving into a disinflationary mode?

What is inflation and how does it affect the economy? When there is a continuous rise in the price level, it is referred to as inflation. Put it simply, inflation is when you pay a higher price for the same commodities purchased over a period of time. While disinflation is a decline in the rate of increase in average prices, deflation connotes to a sustained fall in prices. In India, the Wholesale Price Index (WPI) is the most popular method of measuring inflation compared to the Consumer Price Index (CPI), which is used widely across the globe. There are reasons for this. The basic advantage of having WPI as a measure of inflation is its availability at high frequency, i.e., on weekly basis with a gap of about two weeks, thereby enabling continuous monitoring of the price situation for policy purposes. CPI is compiled on a monthly basis and it requires a regular survey from a highly dispersed market, which is quite difficult in a developing country like India. Getting back to the inflation levels that India is presently experiencing, are these levels indicative of the maturity of the system? Or is this a mere accident? Has inflation been tamed?

Skeptics of WPI-based inflation accounting allege that the method fails to capture the true nature of inflation prevailing in the economy. To some extent this is true, as the services sector, which accounts for around 50 percent of the GDP, has no representation in the bunch of goods considered to measure inflation. WPI takes into consideration manufactured goods, which constitutes a mere 17 percent of GDP. Continuous price changes taking place in the rest 83 percent of the goods and services market is completely ignored while calculating WPI. This makes the WPI in its entirety a false representation of the inflation rates as compared to developed countries. To quote P Balakrishnan, Professor of Economics at IIM-Kozhikode, Kerala, "In India we leave out the price of services such as rent and interest rates. This could understate inflation when the price of services rises faster than the general price level, as has happened in the case of housing sector in recent times." However, this matter is being addressed as the industry ministry has asked the Reserve Bank of India (RBI) to prepare a list of services including banking and insurance services that will be used for the new business services price index.

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