Inflation assessment: some unexplored issues
India has multiple inflation indicators. There are four consumer price indices (CPIs). Besides the aggregate countrywide CPI, there are sector-specific CPIs for agricultural labourers, rural labourers and industrial workers. These sector-specific CPIs are used for fixation of agricultural wages, rural wages and the inflation compensation or dearness allowances for employees in the government and its parastatals. In addition to these CPIs, there is a wholesale price index (WPI), which until recently was the preferred inflation anchor because of its wider coverage, a short time lag and weekly (it became a monthly index from 2011) availability.
The new series of CPI with its all-India coverage, updated base and availability with similar time lag has become the new inflation anchor for India and a basis for monetary policy changes. This shift in the focus and use of CPI has not only been in line with many other countries, formally or informally having an inflation target approach, but it is also consistent with the objective of minimizing the impact of rising prices on people. However, C. Rangarajan and R. Kannan , in a recent article in the The Hindu Business Line, pointed out: “If WPI is behaving in the same way as CPI, there is no additional information. But if it behaves differently,...policymakers cannot afford to ignore the behaviour of WPI. WPI is not simply a reflection of international commodity prices, it also reflects domestic conditions.”
CPI looks at inflation purely from the perspective of a consumer and ignores the prices that a producer faces. Further, the CPIs, in whatever format these are compiled, completely ignore the inflation for investment and capital goods. In fact, the diverging trends between WPI (which is more akin to a producers’ price index) and CPIs has largely been due to the two sets of prices that now confront producers and consumers. Average inflation for manufactured products, further sub-divided into consumer non-durables, consumer durables, intermediates, basic goods and capital goods, cleanly indicates that inflation during the 32-month period (January 2014-August 2016) has averaged 2.8%, 1.8%, 0.7%, (-) 1.3% and 1.2% , respectively, as against CPI, which averaged 5.7% (see chart 1). Low inflation in these commodity groups has in fact persisted for the last three years or so.
The use of CPI as an exclusive inflation anchor has in a way ignored or overlooked the concerns about investment. The rate of growth of gross fixed capital formation (GFCF) in the last 10 quarters at 3.5% has been only half of the gross value added and only a shade above 50% compared to the growth in consumption. There has also been a sharp moderation in the ratio of GFCF of over 565 basis points between Q4 of 2012-13 and Q4 of 2015-16 . A slower growth of GFCF and a lower allocation of income to investment could be because of two factors. First, there may be apprehensions about the sustainability of the growth as excess capacity is already available and, second, given the competitive situation, entrepreneurs may consider investment a bit risky. The continued leveraged position of the Indian companies may also be a dampener for investment. Further, high interest may be one of the critical factors affecting domestic investment. While temporarily growth could be sustained by a reduced implicit incremental capital output ratio (ICOR), a decline which has persisted since Q4 of 2013-14 may not happen; more so as new growth may be more skill and capital intensive.
Another question which is relevant for the assessment of inflation is the use of weights. The CPI (which is the inflation anchor) uses the consumption proportions as derived from the National Sample Survey Office (NSSO) consumer expenditure surveys for inter-commodity weights. But there are huge differences between NSSO consumption expenditure and the expenditure as derived from the National Accounts Statistics (NAS), both at an aggregate level and at the level of commodity groups. This gap has also been widening over the years.
Using the NAS weights for the commodity-specific indices of CPI (all India), we observe a moderation in inflation by nearly 60 basis points during the aforementioned 32-month period. While the trend is unmistakably the same, the CPI adjusted for NAS weights has always been lower than the CPI with NSSO weights (see chart 2).
This adjustment may be necessary as the current CPI is based on partial data on consumption and not the complete data. The adjusted CPI inflation is not only below the maximum threshold level of inflation, but with expectation of moderating inflation because of improved availability of food products, is also indicative of a possible moderation in policy rates in the near future by the Reserve Bank of India.
Management of inflation has always been a tricky issue because the interest rate, which is used as the key policy instrument, is double-edged. While containing inflationary expectations, it also affects adversely the investor perception and investment costs. The use of a single inflation anchor in a situation of divergent inflation perceptions for consumers and producers may often amount to ignoring the structural realities of the economy. However, the current official mandate is for the use of CPI in targeting inflation, but scope exists for using CPI with commodity weights being derived through NAS rather than NSSO. The monetary authorities, while trying to use CPI as a consensus inflation anchor, may well benefit by considering the other indicators as well, particularly in a situation where the single-indicator CPI is at odds with WPI, the other inflation indicator.
R. Gopalan and M.C. Singhi are former secretary, and former senior adviser, respectively, at the department of economic affairs.
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