Will wholesale inflation fall in FY23 as the Centre expects it to?

Govt's conservative nominal GDP growth estimate suggests it expects a low-inflation, high-growth FY23. But there are potential downsides to growth & upsides to inflation, especially wholesale

The Union Budget of 2022-23 projected a very conservative estimate of nominal growth in India’s gross domestic product. It said that India’s nominal GDP will grow 11.1 per cent next year. An estimate of real GDP growth would then tell us what would the implicit price deflator in FY23 be. The deflator--the difference between the real and nominal GDP growth--is one measure of the general inflation in the economy. 

The Budget does not offer an estimate of real GDP growth. But the Economic Survey, which is prepared by the economists in the Ministry of Finance, does. The Eco Survey pegs real GDP growth in FY23 at 8-8.5 per cent. This figure is close to the average of what domestic and global agencies are forecasting.

If we consider that real GDP growth would be 8.25 per cent (mean), then the price deflator for FY23 comes out to be 2.85 per cent. The growth projections of Eco Survey and the Budget thus mean that the general inflation in India next year would be low. 

Now, the deflator is a combination of producer price index based (wholesale) inflation, and consumer price based (retail) inflation. Given that the Reserve Bank of India has forecast 5 per cent retail inflation in the first half of FY23, and the strong likelihood that retail inflation will remain above 4 per cent in the second half, the Centre’s assumption of a low deflator boils down to low wholesale inflation in the next year. 

WPI inflation has been record high in FY22 under the current series that began in 2011-12. It touched 14.2 per cent in November 2021. 

In his post-Budget interaction with the press, and in his interaction with Business Standard, Finance secretary T V Somanathan said that this very fact—a high base effect—will bring down WPI inflation in FY23. But what is the likelihood that wholesale inflation will indeed drop? We cannot assign a number to the probability, but can explore the potential factors that will affect WPI inflation going ahead. 

First, a look at history: If we look at the last 50 years of wholesale inflation in India, we see that periods of high WPI inflation have mostly tended to drag, or extend beyond two years. 

Instances of short bouts of high WPI inflation have also been there, but elongated periods seem to be more conspicuous, if we refer to five different WPI series from 1970 to date. Even when it falls, it tends to hang in there for some time. 

This suggests that wholesale inflation tends to be stickier, and hold on to its level—be it high or stable or low—for longer periods than consumer inflation. Needless to say, it always depends on the situation at that point of time. 

India has had high deflators in situations when either WPI or CPI inflation are high. When both are high, deflator turns out to be higher than any year in comparison, as seen in 2021-22. Similar was the case in 2012-12, when inflation at both the consumer and producer level was high.  

Let's recall that the implicit deflator for 2022-23 can be as low as 2.9. Now, the only periods in which deflator has been close to a level as low as this, is when WPI inflation has been close to 0 per cent or negative, a situation when prices nearly fall for producers.

The reason for this is that consumer inflation has generally tended to be close to the 4 per cent level during those times. 

CPI inflation is projected by RBI to be close to 5 per cent in a large part of FY23. So the only way the general price deflator can be below 3 per cent, is when WPI inflation falls from its current levels to low single digit levels.

Is such a feat possible? There are several upsides to wholesale inflation, and some downsides too. A combination of the following factors will decide its trajectory. 

Firstly, it's the global commodity up-cycle that has maintained itself till now. Record prices of raw material, record high shipping turnaround times, record food prices have been the case in the pandemic. Crude oil is inching up once again. If this continues in FY23 for India, producer prices may not soften so quickly. 

Then, there are geopolitical tensions arising out between Ukraine and Russia, which may have an impact on supply chains across the world, and on prices of commodities that bear on the region. 

India’s dependence on imports has risen, as December 2021 recorded the highest ever imports India has made. In fact, the Eco Survey pointed out that India should be “wary” of inflation, and especially, imported inflation. 

But there are counter arguments too. China is slowing, and so are the US and the EU. Interest rates will rise in key economies, and the spurt of growth in response to the pandemic will smoothen into a stable but low growth phase in the world. The International Monetary Fund has cut its growth forecast for 2022 for major economies in the world, mostly attributing it to the recent wave of Covid-19. 

But slowing growth may soften the commodity up-cycle, and apart from the energy sector, the impact of “imported inflation” may moderate later. Economists that Business Standard spoke to think that moderation in consumer and producer inflation may be visible in the second half of FY23. 

In the last meeting of the monetary policy committee, RBI deputy governor Michael Patra pointed to the “bullwhip” effect that’s in the making in advanced economies right now, wherein a large part of the high growth in AEs in recent quarters has been on account of piling up of inventory, and not really consumption. This may lead to fall in prices in coming quarters in some segments, resulting in dampening inflation, contrary to expectation, he contended. 

Finance secretary Somanathan did not just depend on low wholesale inflation while arriving at the nominal GDP for FY23. He also pointed to potential downsides in real GDP growth due to the impact of the recent wave of coronavirus on consumption in the economy.  

Consumer spending in real terms (private final consumption expenditure) in 2021-22 is still less than 2019-20 levels, and is barely 3 per cent more than 2018-19 levels. 

The continuing dent to consumption gets further underlined through high levels of household inflation expectations against moderate levels of actual consumer inflation. Households expect inflation to be above 12 per cent for both the three-month and one-year ahead periods, while actual consumer inflation is in the 5 per cent range. 

So the ship could go either way. Low nominal growth could translate into moderate inflation and a real GDP growth on the lower side of analyst estimates, in the sub-8 per cent region. 

Or, wholesale inflation could indeed fall owing to a multitude of factors, and real GDP growth may come in as rosy as it is expected to be. 

For now, India Inc would be taking the nominal GDP growth number provided by the Centre in the Budget very seriously. It is the only estimate they have, and it directly feeds into their top line!