Is RBI's navigation system for monetary policy faulty?

WPI based inflation should not be an important input for monetary policy

Medical science says that poor diagnosis leads to poor treatment. If the data based on which an inference is to be made is either wrongly collected or the sample size is poor, then the inference and recommendation made on it will not have the desired effect. In some cases it can also be counter-effective. 
 

India’s inflation data and RBI’s policy based on it also runs on the same logic.Kunal Kumar kundu in his article in Business Standard argues the point that WPI based inflation should not be an important input for monetary decision. WPI is highly volatile as it is always subject to change or revision. Between January 2010 and April 2013, WPI based inflation was revised 38 times out of which 32 times were upward revision. As if this was not enough, these revisions were done, two months after the first announcement. If WPI is a navigation tool, RBI is driving in the wrong direction. 

 

WPI based inflation data has become more critical recently as it is very close to RBI’s comfort zone of 5%. The latest data shows that WPI has touched a figure of 4.86%, which is well within the comfort zone. However, the average upward revisions have been 0.38%. Now if the current data needs an upward revision, WPI would have entered RBI’s danger zone. 
 

Kundu points out a number of cases where the initial data reflected no change, even though changes had taken place on the ground like diesel and coal prices. 
 

This time around too,core inflation, which indicates demand side pressure on prices,has been falling since the second half of 2012-13. Non-food manufacturing inflation, RBI’s core inflation measure fell to a 42 month low in June, while CRISIL Core Inflation Indicator (CCII), an alternative measure of core inflation has fallen to a 45 month low. Kundu says RBI’s indicator is being overstated due to sharp fall in metal prices which has been affected by global factors and not domestic. As a result CCII of 3.6% is the more realistic figure than the 2% used by RBI. This calls for another case of upward revision.
 

The other case is about the futility of forming monetary policy based on WPI inflation, when the impact of policy measures is felt by the consumers directly. Is Consumer Price Index (CPI) a better and more realistic inflation calculator? Off-late the gap between WPI and CPI is widening on account of higher logistics cost, higher profits by middle man among other reasons. The net result is the man on the street buys from the local vendor and not the wholesaler. So why base a policy which will impact the consumer but use inputs of the wholesaler. 
 

While the arguments might be in favour of CPI based inflation, the fact is that CPI is moving continuously higher and WPI seems to be under control on account of various measures taken by the RBI. The central banker will need constant interaction and intervention from the government to control CPI. Perhaps RBI is not comfortable with its current role of a back seat driver. 

Till such time that a more realistic input data is used we will have to be contented with taking wrong turns as the WPI based navigator repeatedly goes in for course corrections.