Deflation again in India after three decades !!!!!!!!!!

The Theory…..!
Deflation is a progressive reduction in the price level (Oxford). Deflation occurs when the annual inflation rate falls below zero percent, resulting in an increase in the real value of money — a negative inflation rate. This should not be confused with disinflation, a slow-down in the inflation rate (i.e. when the inflation decreases, but still remains positive). Inflation reduces the real value of money over time; conversely, deflation increases the real value of money.This would make real interest rates exceed nominal interest rates, which might make it impossible to lower nominal interest during a slump sufficiently to make real investment appear profitable. This is known as the “liquidity trap”. That is deflation is related to risk: where the risk-adjusted return on assets drops to negative, investors and buyers will hoard currency rather than invest it, even in the most solid of securities.
Deflation is caused by a shift in the supply and demand curve for goods and interest, particularly a fall in the aggregate level of demand. That is, there is a fall in how much the whole economy is willing to buy, and the going price for goods. Because the price of goods is falling, consumers have an incentive to delay purchases and consumption until prices fall further, which in turn reduces overall economic activity - contributing to the deflationary spiral. Deflation is generally regarded negatively, as it causes a transfer of wealth from borrowers and holders of illiquid assets, to the benefit of savers and of holders of liquid assets and currency. In this sense it is the opposite of inflation (or in the extreme, hyperinflation), which is a tax on currency holders and lenders (savers) in favor of borrowers and short term consumption. In modern economies, deflation is caused by a collapse in demand (usually brought on by high interest rates), and is associated with recession and (more rarely) long term economic depressions. Thus deflation can occur because of a combination of four factors:
1. The supply of money goes down.
2. The supply of other goods goes up.
3. Demand for money goes up.
4. Demand for other goods goes down
Deflation generally occurs when the supply of goods rises faster than the supply of money, which is consistent with these four factors. These factors explain why the price of some goods increases over time while others decline. Demand falls, and with the falling of demand, there is a fall in prices as a supply glut develops. This becomes a deflationary spiral when prices fall below the costs of financing production. Businesses, unable to make enough profit no matter how low they set prices, are then liquidated. Banks get assets which have fallen dramatically in value since the (mortgage) loan was made, and if they sell those assets, they further glut supply, which only exacerbates the situation.

What is happening in India?
For the first time in over 30 years, the year-on-year inflation strayed into negative territory at minus 1.61 per cent for the week ended June 6. The last time inflation turned negative was in late 1974-early 1975. This was the result of the severe anti-inflation package of July 1974 to compress demand and reduce money supply necessitated by the galloping inflation of the previous 18 months caused by the two poor monsoons of 1972 and 1973, and the first oil shock of October 1973 (The Hindu Business Line).
The major reason for negative inflation was the base effect. High inflation last year always made the rate of price rise look less in the current year.

What is WPI? Why there is a mismatch between WPI and CPI?
The Wholesale Price Index or WPI is the price of a representative basket of wholesale goods. Some countries use the changes in this index to measure inflation in their economies, in particular India – The Indian WPI figure is released every 10 days and influences stock and fixed price markets. The Wholesale Price Index focuses on the price of goods traded between corporations, rather than goods bought by consumers, which is measured by the Consumer Price Index. The purpose of the WPI is to monitor price movements that reflect supply and demand in industry, manufacturing and construction. This helps in analyzing both macroeconomic and microeconomic conditions. There are altogether 435 articles/items in the new series (1993-94 as base) of Whole Sale Price Index (WPI), comprising of 98 primary articles 19 items of “fuel, power, light and lubricants" and 318 manufactured items, making up the sample basket of the 1993-94 Wholesale Price Index series. But this is not the index that affects you. What impacts the ordinary consumers is the Consumer Price Index. Interestingly the various consumer price indices show an increasing trend in India. Why this is so? The point is, if the weightages in the two indices are so different. The major culprit is the price rise in food, which is given a much lower weightage in the WPI than in the CPI. The weightage of food items in the WPI is only 15.4%; in the CPI, it accounts for almost half the index: 47.13%. The effect of soaring prices in food is reflected far less in the WPI than in the CPI. This has single-handedly widened the gap between the two indices. Thus high food prices are still not reflected in the overall rate of inflation since primary articles (which include food) enjoy a weightage of 22.02 per cent in calculating WPI. In the calculation, the Government presumes that the common man spends almost 80 per cent of his wages on manufactured goods and fuel. The Government is busy playing up the low WPI, while the Consumer Price Index (CPI), which actually reflects the burden on the consumer’s pocket, is still very high. When we talk about industrial workers, their wage is in a declining trend because of the decline in WPI and at the same time they have to spend more for their food. This is really a very complex situation that the Reserve Bank of India and the Government is trying very hard to tackle. Moreover, the present situation also throws light that the benefits of the cheap money policy by the RBI and pump priming policy of the government is not reaching the large sections to the economy. In a way it is good to have a deflation situation now that the government can include more proactive policies in the coming national budget.
Definitely the present situation is not the one that the global depression starts feeling in India. In my opinion the present deflationary pressure in India is as expected and it will not sustain long and will recover the economy within two weeks of time. Why because, 1) the government is thinking about the upward rise in fuel prices in the economy, 2) the national budget is coming in two weeks 3) RBI is going to come with even more cheap money policy 4) CPI is still very high in India 5) The changes in the capital market is favorable and 6) the marginal propensity to consume of the majority of the people in India is still very high. This is not the time to get panic.

References and Sources.
1. “The Oxford Dictionary of Economics”, John Black, Oxford University Press, 2008.
2. “Macroeconomic Theory”, Gardner Ackley, The Macmillan Company, 2007.
3. “The Hindu Business Line” Various issues
4. “The Financial Times” Various issues
5. Central Statistical Organization, Govt. of India.
6. Ministry of Finance, Govt. of India.
7. Planning Commission, Govt. of India.