India`s benchmark wholesale price index (WPI), inflation fell to 0.27% for the week ended Mar. 14, 2009 as compared to 0.44% a week ago. In contrast, it stood at 8.02% during the corresponding week of the previous year. While the fall is less than what I expected, it still is a clear indication that we are heading toward negative inflation rate region. 

An important question of course remains as to whether WPI is a real indicator of inflation. There’s enough evidence to know that retail prices are hardly budging even in the wholesale prices show a downward trend. In effect, none of the Consumer Price Index (CPI) indicators are showing a falling trend. If anything, these are still headed upward and hurt the common man. There is of course a lagged transmission effect and I expect the CPI to start trending down soon. Though it is highly unlikely that it will fall as low as the WPI has.

In fact, as was mentioned in my previous post, I am yet to be convinced that we are heading toward deflation. To me it continues to be more of a statistical phenomenon where the high base effect has kicked in. Deflation will likely kick in only if we see a big and sustained contraction in output, maybe 5% plus. Hence, the real economic data for the next few months would turn out to be crucial.

On the policy front, this calls for further rate cuts. However, whether this rate cut(s) will translate in lower interest rates in the economy is not very clear. In fact, today the interest rate on 10-year government bond has crossed the 7% mark, which is already 2% more than what it was January, What will also queer the pitch is the humungous borrowing need of the government to meet the requirements of the various stimulus packages announced by them.

Those who are optimistic of the recessionary trend waning toward early next year would need to think twice. The financial sector crisis is far from being over and credit card delinquencies would be the next wave to hit them.

That the US consumers are in great distress is nothing new. Please refer to my article http://www.rediff.com/money/2008/nov/06bcrisis5.htm. As they are cutting back on consumption with great vigour, the US economy is feeling the hit, and big time at that. But that is only a part of the story. The US consumers are now finding it increasingly difficult to even make payment for their credit card dues. The rising rate of credit card delinquencies clearly shows the stress they are in.

This becomes amply clear from the following chart:

Source: Federal Reserve Bank

The 4th quarter delinquency rate (@ 5.56%) is the highest in over a decade and is unlikely to reverse anytime soon. The recently released data for the month of January shows total outstanding credit at more than USD 2.5 trillion. Nearly 40% of this (or about USD 1 trillion) is revolving credit and that’s a big worry.

It is quite well known that late payments and defaults on credit cards are closely linked to levels of unemployment, which have risen dramatically. Non-farm employment fell 524,000 in December, contributing to the biggest decline in payrolls on a three-month moving average since 1945. The unemployment rate jumped to a 15-year high of 7.2%, from 6.8% in November.

Surely we are not going to be out of the woods anytime soon.

Inflation (as measured by the Wholesale Price Index i.e WPI) today fell to as low as 0.44% (as compared to 2.43% recorded a week ago) something that has not been seen in the last two decades. More importantly, the YoY fall in the weekly Index number was a whopping 199 basis points . Whew. 

At the rate the inflation number has been moving, we are all set to touch zero inflation (if not slightly negative) before this month end. Maybe, by next week itself. If the index value drops by 0.3 to 226.4 from the current 226.7, zero inflation will be recorded.

Is that a concern really? Is India headed for deflation? 

I doubt. Deflation does not seem to be a concern. In fact, it may be termed as disinflation, rather than a deflation. This is more of a statistical phenomenon as the base effect kicks in big time rather than a situation of a drastic fall in price due to sustained decline in demand. So even if there is a negative inflation for some months going forward, the base effect will start kicking in again and inflation will move back to the positive territory. My hunch is that inflation might remain in negative territory for the next three to four months after which the reversal might be visible. Only if the real economic data takes a turn for the worse (much more than expected) will the specter of deflation loom in the horizon. As of the indications do not point to such worsening of scenario.

What this means is that, inflation will cease to be a problem for us for the next, atleast, six months. On the policy front, this development makes a case for further softening of interest rates.

What a change. Is it a reflection of changing global order? Maybe, if not certainly.

As recent as in late January (refer my article http://in.rediff.com/money/2009/jan/30bcrisis-tough-times-ahead-as-us-moves-towards-protectionism.htm) Mr. Geithner accused China of manipulating its currency. Now it is China’s turn to get even. Its premier Wen Jiabao openly accused the US of mismanaging its finances and hence expressed his concern about the value of Chinese holding of US treasuries.

In late January itself Wen blamed the U.S.-led financial system for the world's deepening economic slump. And now an even sharper rebuke as the Chinese government is clearly worried about the safety of its nearly $1trillion credit to the US government. 

"We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets," Mr. Wen said in response to a question at his annual news conference. "Frankly speaking, I do have some worries."

Not surprising since China has now overtaken Japan as a country having maximum appetite for US treasuries.

Source: US Treasury

US response to the concern was swift and on expected line. "There's no safer investment in the world than in the United States," said presidential spokesman Robert Gibbs. This was followed by assurance from White House officials that US would embark on the path of fiscal prudence once the crisis blows over.

Surely the US is concerned about this development. Given their increasing dependence on Chinese subscription to their treasuries to help fund their fiscal measures, they are a worried lot. Worried that the Chinese tap might reduce its force of spewing out the dollars. 

On the other hand, the Chinese worry is justified given that the US is in its deepest recession probably since the last Great Depression, its deficit is rising and yet there is no certainty that all their pimp priming measures will rescue the economy anytime soon.

Clearly, China is facing a dilemma. If it starts selling treasuries, the treasury market will collapse lowering the value of the Chinese investment. If China keeps on accumulating US debt, the risk profile of their reserves will rise. While the worry is real, China is not expected to start selling treasuries. However, with shrinking trade deficit, China’s ability to accumulate US treasuries will also be less. Nevertheless, this development clearly shows the increasing clout that China now is now able to command in the world market.

We are living in interesting times indeed.