The large magnitude of the divergence between the two indices makes it difficult to assess the inflation dynamics in India presently.
There are two measures of inflation in India: the Wholesale Price Index (WPI) and the Consumer Price Index (CPI). As the name indicates the WPI measures prices at the wholesale level and CPI at the consumer level. Beyond the basics, the number and types of items included in the WPI and CPI basket differ and so does the weights given to these items. Primary articles, consisting of food articles such as cereals, meat, fish and vegetables; and non-food articles such as cotton, cooking oil, jute and minerals, etc are given a weight of about 20% in WPI. The second sub-group is fuel and power, which is given a weightage of 15% and finally manufactured items consists of 65%. In the CPI basket, there are five main sub-categories, which are Food and beverages (35.8%), Fuel and Light (8.4%), Housing (22.5%), Clothing, Bedding, and Footwear (3.9%), and Miscellaneous group which includes services (28%).
Given that the CPI measures retail prices, it is bound to be higher than the WPI, which measures wholesale prices. This has been the case for a long time now and is not a cause for concern as long as both the indices are moving in the same direction. The central bank can gauge the general trend of inflation. However, the latest WPI data available for June was at -2.4% and CPI inflation was at 5.4%, a whopping 7.8% difference. There has been significant divergence between the two indices since November 2014, with the WPI steadily dropping and the CPI inflation crawling upwards, as this graph indicates.
The exact reasons for such a sharp divergence remain unknown. Mr. Subbarao, former Governor of RBI admitted that “We do not yet have a full understanding of the process by which wholesale price changes are transmitted to retail prices or of the magnitude of the associated pass-through and lags.”
The divergence between the wholesale and retail prices could indicate that there is an increasing inefficiency in the supply chain between the farmers, producers and the end consumer. The middle man might be making gains. Another reason could be that one of the indices is seriously wrong or is not capturing what it should.
Another cause is the structure of the different baskets. As nearly 65% of WPI is made of manufactured goods, reduced global oil and energy prices would have played a big role in lowering costs. Also, there is a general slack in the manufacturing sector in India at present, which is corroborated by low and falling IIP numbers. For the CPI, prices of food, housing and services, the three big components, have not shown any indications of easing.
It is also important to note that WPI index is usually the lead index and CPI lags behind. It takes time for the wholesale prices to pass through to retail. Historical data indicates that CPI usually converges with WPI after a considerable lag.
Regardless of the cause for the divergence, it has serious implications for monetary policy decisions. While the RBI solely focussed on the WPI before the current Governor, Raghuram Rajan took office in 2013, it now focuses unilaterally on the CPI as the leading indicator of inflation in India. Arvind Subramaniam, the Chief Economic Advisor to the PM commented on this, asking the RBI to consider both WPI and CPI while making a decision on interest rates.
Both wholesale prices and consumer prices are important, but to different agents. Consumer behaviour is usually a response to the trajectory of retail inflation but companies decide based on wholesale price movements. The large magnitude of the divergence between the two indices makes it difficult to assess the inflation dynamics in India presently and makes it harder to take a decision based on contradicting data.
Anupam Manur is a Policy Analyst at Takshashila Institution. He tweets @anupammanur