Tracking CPI inflation is more important than WPI: Morgan Stanley

Consumer price index-based inflation would fall by 3.9 percentage points to around 7% by March

Amid a debate over which price index is a better indicator of inflation — consumer price or wholesale price — Morgan Stanley has cast its vote in favour of the retail price one, at least for now.

It predicted the consumer price index (CPI)-based inflation would fall by 3.9 percentage points to around seven per cent by March 2014 from 10.9 per cent in February 2013. Besides, it noted a substantial reduction in CPI inflation is needed for any sustainable cut in interest rates.

A report by Morgan Stanley Research on India Economics said tracking CPI inflation was more important in the present cycle as WPI was not adequately capturing the underlying inflation pressures in the economy.

It based its thesis of a fall in CPI inflation on five factors — lagged impact of slower growth in government expenditure, moderation in rural wages growth, modest rise in global commodity prices, particularly oil, cooling of growth in asset prices particularly housing and decline in growth of domestic demand.

The CPI inflation data for March 2013 is slated to come on Friday.

It said total government spending had been on a decelerating trend since September 2012. Moreover, the government has controlled expenditure ex-interest and subsidy payments.

“Indeed, total expenditure less subsidies and interest payments decelerated to 3.8 per cent year-on-year (y-o-y) between September and February 2012-13 from growth of 11.4 per cent between April and August 2012-13,” it added.

The research report pegged the Centre’s fiscal deficit at 5.4 per cent of gross domestic product (GDP) in 2012-13, contrasting Finance Minister P Chidambaram, who had said the deficit would be lower than 5.2 per cent.

It pegged the deficit to come down by 0.4 percentage points in 2013-14, but even then, it would still stand at five per cent. The government target is to contain it at 4.8 per cent of GDP in the current financial year.

However, the report is largely on CPI inflation. “As the government delivers fiscal consolation, it will help contain aggregate demand – thus reducing inflationary pressures in the economy,” it said.

Another pressure to cool down prices will come from moderation in growth in rural agriculture wages, which declined during the three-month period ended January 2013 after accelerating for five years. “Rural farm wage growth has now decelerated to 17.9 per cent y-o-y for the three months ended January 2013 from the peak rate of 22 per cent during the three months ended October 2011.”

This moderation, the report said, would help lower food production costs and ease food and overall inflation. The weakness in global agricultural commodity prices should also help moderate food inflation.

CPI inflation will also face a downward pressure from slower rise in global commodity prices, particularly oil. A large part of intermediate and input prices are linked to global commodities.

For instance, 38.4 per cent of the WPI items, which largely represents manufacturing input and intermediate prices, are influenced by global commodity prices.

The report said crude oil prices are declining on a y-o-y basis, which should help ease cost-push pressure from imported commodities, particularly oil.

The report said CPI inflation for housing has been decelerating steadily due to moderation in growth of residential property prices.

Inflation in housing, which has a weight of 9.8 per cent in CPI, has moderated from the peak of 15.7 per cent in May 2012 to 10.5 per cent in February 2013, but still remains high. Moderation in property price rises would likely further slow inflation in housing with a lag.

Lastly, domestic demand growth has decelerated sharply from 9.3 per cent during the quarter ended June 2011 to 4.4 per cent in the quarter ended December 2012. “We believe this sharp slowdown in domestic demand will finally start weighing on CPI inflation trend over the next six months,” the report added.