Inflation vs inflation

The odd divergence of wholesale and consumer indices

For a long time now, Indian macroeconomic management has dealt with the dilemma of how to best measure inflation. Endless commentary on the virtues and vices of the wholesale price index (WPI), several consumer price indices (CPIs) and the gross domestic product (GDP) deflator kept analysts occupied. Finally, resolution and clarity were supposed to be provided by the new all-India CPI, which was first published in 2011. This new index was expected to address all the shortcomings of the previous indices and, in the process, provide the Reserve Bank of India (RBI) benchmark consistent with global practice in making monetary policy decisions. However, the early performance of the new index has belied those expectations. The WPI and the new CPI have significantly diverged and, consequently, the debate between the pro- and anti-WPI viewpoints has not abated at all. With the RBI's recent and prospective interest rate cuts being very much in the spotlight, the softening in the WPI provides a rationale for these actions, while CPI inflation, still in double digits, cautions against them. The critical question is whether the divergence between the two indices is contributing to significant policy errors.

A recent research note by JPMorgan examines the divergence between CPI - not the new one, because of its short life, but the old CPI for industrial workers - and the WPI. The analysis suggests that the predominant cause of the large divergence is food. This results from both the much larger weight for food in the CPI and, importantly, the composition of the basket in each index. The latter has a larger share of food items whose prices have been rising relatively fast. What are the implications of this finding? On the one hand, it validates the use of the WPI as a benchmark that captures the inflationary conditions that consumers are experiencing outside of food. On the other, however, to the extent that food prices are an important influence on the inflationary expectations of a large proportion of the labour force, high CPI inflation could pose risks for entrenchment of expectations and persistence of inflation. So, policy should prioritise inflation management until this number descends to reasonable levels. In short, there is still ambiguity.

But beyond this relatively long-term pattern, comparisons between the specifics of the new CPI and the WPI do raise some concerns. For example, core inflation, or inflation in non-food manufactured products, appears to have declined far more significantly for the WPI than for the new CPI. Of course, the goods covered by the two are quite different, but even if more disaggregated comparisons are made, discrepancies are observed. Data quality could, of course, be one reason for this, but does it also reflect some structural rigidities in the retail system, which is not allowing lower wholesale prices to transmit through to the consumer? Until the much-desired clarity on this finally emerges, making monetary policy is like driving a vehicle with two speedometers. You can simultaneously be challaned for driving too fast and too slowly!