User register and login test
Found the solution. Just for future references for others and me as well :-)

There is an issue in Services module Wrong username and password, just after a creation of a user where someone faced the same problem. User login just registration. So as it stated,


  If you are anonymous user and register a user your register form does not have password field at all. It has only username and email fields. All instructions are sent by email (with token to log in and set the password). So register call actually does not set the password.


This is actually true. If I go to the admin and change the password again then it's working. So the solution is to alter two variables,

variable_set('user_email_verification', FALSE);
variable_set('user_register', TRUE);


This will now allow the users to register by themselves.