Graphic: Santosh Sharma/Mint
Graphic: Santosh Sharma/Mint

A forgotten inflation index could hold key to RBI’s slowdown assessment

  • With the adoption of inflation targeting, RBI changed its nominal anchor to Consumer Price Index-based inflation and rightly so
  • WPI captures prices at the factory, mandi and essentially at various levels in the supply chain of goods before it reaches the end consumer

Nearly five year ago, the Wholesale Price Index (WPI)-based inflation used to be the nominal anchor for the Reserve Bank of India’s (RBI’s) monetary policy and much angst was expressed every time the central bank hiked rates to curb inflation.

With the adoption of inflation targeting, RBI changed its nominal anchor to Consumer Price Index-based inflation and rightly so. Retail inflation captured prices at the consumer level and included services, which were a growing component. WPI’s shortfall was the non-inclusion of services, and a large weightage of 64% accorded to manufactured products.

But, it is this shortfall that makes WPI more relevant today than before.

WPI captures prices at the factory, mandi and essentially at various levels in the supply chain of goods before it reaches the end consumer. In that, it is the best measure for the pricing power of manufacturers. A collapse in WPI indicates that Indian companies do not have any pricing power. This sits neatly with a persistent slowdown in demand that is currently under way.

The adjoining chart shows a collapse in the manufactured products inflation within WPI. In September, manufactured products inflation was a minus 0.42%. In other words, it has slipped into deflation. The factors behind this were a sharp fall in global commodity prices that dragged down the basic metals component as also the drop in other products.

According to analysts, the stark fall in WPI indicates that the demand slowdown is pervasive in all parts of the economy. “The sharp fall in WPI index manufactured products corroborates the persistent weak demand conditions in the economy eroding the pricing power of Indian manufacturers. We are seeing it in the auto sector through the discounts already," said Shubhada Rao, chief economist at Yes Bank Ltd.

Indeed, out of the 22 different product categories, the fall in inflation was steep in 15 categories and 10 were in deflation in September within the manufactured products index. The steepest fall is in basic metals index, which entered into a deflation of 8.23% in September from an inflation of 14% a year ago. This fall is largely due to the drop in international commodity prices. Abheek Barua, chief economist at HDFC Bank Ltd, noted that WPI is a good input in assessing economic growth since it captures the imported inflation or disinflation too.

Most multilateral organizations have slashed their forecast on India’s economic growth for FY20. Moody’s Investors Service perhaps has the most bearish forecast of 5.8%. RBI’s forecast stands at 6.1%, backed by a slowing industrial production and surveys indicating moderation in expectations. Perhaps WPI’s trajectory would show how deep the slowdown is and the extent of bearishness in expectations of both business and consumer.

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