Inflation is a politically sensitive subject but few understand the calculation methodology. In addition to complex methodology, inflation data gathering is suspect. There are always multiple revisions to the preliminary numbers and the changes may be of large dimensions.
The market responds to the preliminary number and if that is out of kilter, the market response may seem irrational in hindsight. The wholesale price index (WPI) is the chief gauge of inflation in India. The Indian consumer price index (CPI) is taken less seriously. The Reserve Bank of India (RBI) also calculates “core inflation”, excluding volatile energy and food prices from WPI. The year-on-year (y-o-y) change in WPI is used as the rule of thumb method for calculating the inflation rate. YoY is deceptive if the base month had exceptionally low or high inflation. It also doesn't yield a sense of the average inflation rate.
The recently released data included a few points worth noting. The December WPI showed a y-o-y change of 7.2 per cent, which was the lowest rate in over two years. The revised data for October was 7.3 per cent, which is lower than the preliminary estimate of 7.45 per cent. This suggests WPI is indeed falling. A look at the WPI series itself, rather than changes in its values, also shows a flattening line. Out of the WPI components, manufactured goods rose just five per cent. However, commodities (primary goods) are priced high at 10.6 per cent and fuel is at 9.4 per cent.
There was a big discrepancy when comparing WPI to the CPI numbers. CPI is running at 10.56 per cent, which is the highest since the current series was initiated in January 2011. Food is up 13 per cent and clothing and housing are both up over 10 per cent. So, the aam aadmi is struggling to cope with the high prices of roti, kapda and makaan. Rural CPI is also higher than urban CPI, which is even worse news politically.
The stock market rejoiced when the WPI data came in. Coupled with a weak November Index of Industrial Production, it’s seen as ample justification for a policy rate cut when the RBI reviews the Credit Policy on January 29. As a result of this guesswork, a host of rate sensitive stocks have shot up. The central bank does however, have a responsibility to balance growth and control inflation. The high CPI numbers and their political significance might make it hesitate to loosen up. On balance, the RBI is likely to cut repo, I think. But it may be a minimal 0.25 per cent cut. This would be discounted before the credit policy is announced. That might make it a ‘buy on rumour, sell on news’ situation where stocks actually react downwards when the cut occurs.
