At one point in his book Arrow of the Blue-Skinned God, Jonah Blank writes, “When facts are inclusive, truth is what you make it to be.” That, essentially, is the story of inflation in India. Indeed, measuring and tracking inflation here is like the proverbial five blind men touching different parts of an elephant to describe the creature. Each is (partially) accurate in his description, but none captures the complete perspective.
India has more inflation measures than most other countries. There are four consumer price indices (CPIs), and one each of Wholesale Price Index (WPI), gross domestic product (GDP) deflator and personal consumption deflator derived from national income accounts. CPIs and WPI are monthly, while the two deflators are quarterly. Many countries have a producer price index (PPI), but India doesn’t.
Still, India stands out in not having a reasonably reliable high-frequency measure of inflation. CPIs are not available quickly, with most of them using outdated base years and offering little detail. The two quarterly deflators are available with a two-month lag. Given the constraints, it is understandable that the Reserve Bank of India (RBI) adopted the WPI measure of inflation—the least of all evils.
Illustration: Jayachandran / Mint
Although RBI tracks all publicly available inflation measures and has its own in-house non-public inflation surveys, it only forecasts WPI inflation, despite the inherent shortcomings in that measure, including the exclusion of services. Perhaps one day the government will announce a proper CPI measure.
Contrary to popular misconception, WPI and PPI are not the same: Apart from coverage, the key difference between the two is that WPI reflects changes in the average cost of production including mark-ups and taxes, while PPI measures price changes of transacted goods at the gate excluding taxes. PPI is a better measure than WPI.
While almost all countries focus on CPI inflation for policy perspective, India prefers to focus on WPI inflation. Several Asian countries also have PPI, but the broader population and investors are generally far less aware about the monthly PPI trend, preferring instead to track CPI inflation as that typically focuses on a basket that matters to consumers. In India’s case, WPI ends up doing the job done by CPI in most other countries, despite its bias, since the rate of change in WPI is normally bigger than that in CPI.
There are two key challenges that come with using WPI, as the Indian economy integrates with the rest of the world. One, changes in international commodity prices are more quickly and more completely captured in WPI than in CPI. This gives the impression that inflationary pressures are rising faster in India than elsewhere, although this may not necessarily be the case, especially for consumers. Depending on the nature and causes of higher input prices, a complete pass-through of a higher pace of change in PPI or WPI may not be transmitted to CPI. For example, higher cement prices do not generally affect CPI inflation in most countries, but cause the inflation rate in India to increase because of our focus on WPI.
Singapore and Thailand, which are more open to international goods trade than India, have seen input prices surge 13% and 12%, respectively, from a year ago. These magnitudes are higher than the increase in India’s WPI inflation, but both Singapore and Thailand lack the inflation worries palpable in India, despite the fact that both are poised to grow above potential this year. This is simply because the people and the central banks in these countries do not focus on input price inflation.
Two, it is not clear what portion of WPI inflation RBI can actually control through its monetary management. There is not much RBI can do about the food composite index (26.9% weight in the WPI basket). The fuel-related sub-index (14.2% weight in WPI) has a component that is administered (for example, petrol and diesel) and a component that is free to adjust to international prices. RBI’s monetary management has little effect on both, as the price elasticity of demand of the free component is typically low, while the government decides the administered component. That leaves the non-food manufacturing component that has a weight of 52.2% in the WPI basket. This has a large component that is affected by global prices, not to mention the broader push on physical infrastructure by the government.
Aggregate demand management by RBI will have some impact on local demand and, hence, on inflation. However, the focus on WPI and its components that echo changes in global prices much faster and to a greater degree than CPI actually results in quicker and greater transmission of “perceived” inflation. Thus, more often than not, RBI’s success in achieving its WPI inflation forecasts rests significantly more on factors outside its control than on its monetary management.
In the final tally, RBI’s focus on WPI actually imposes an unnecessary handicap in anchoring inflation expectations that other central banks don’t suffer from. It is unlikely that an increase in non-food manufacturing WPI will be fully reflected in a proper non-food CPI index, if India had one. There is too much at stake for India to not properly address the basic question for monetary management that many poorer and less well-endowed countries have perhaps answered better: What is a reasonable, reliable measure of inflation?
Rajeev Malik is head, India and Asean economics, at Macquarie Capital Securities, Singapore. These are his personal views. Comment at firstname.lastname@example.org