WPI contraction doesn't guarantee that RBI's fight against inflation is over

Although the Reserve Bank of India (RBI) committee that sets interest rates targets retail inflation (the consumer price index, or CPI), economists still track the WPI, especially when it enters the deflationary zone. That’s because manufactured products account for two-thirds of the total weight in WPI.

In April all three sub-indices of the WPI – mineral oil, food and manufactured products – saw a significant decline. Manufactured-products inflation hit its lowest level since October 2015.

A number of factors have forced wholesale prices down. Some of these have little to do with what policymakers have been doing to cool inflation.

First, the statistical factor: The high base of last year (15.4%) over which the figure was computed has proved favourable, as was widely expected. The base effect was most helpful in case of the mineral oil index.

Second, rapidly easing global commodity prices are exerting downward pressure on prices of fuels in the mineral oil basket and through lower input costs for manufactured goods (2.4% contraction). Prices of basic metals, chemicals, textiles and manufactured food products also dropped significantly in April. The sub-index contracted (by 0.8%) in March as well.

Third, in the food basket, deflation in prices of milk, eggs, meat and fish, and moderating inflation in vegetable prices offset the higher inflation in prices of foodgrains, especially pulses. The cooling of international prices of edible oil helped to lower inflation here.

The moderation in inflation of vegetable prices is seasonal and vulnerable to the vagaries of the monsoon and heatwaves. The price index for fruits spiked sharply. In step with the international trend, paddy prices increased and wheat prices declined, though not significantly.

Will the contraction in wholesale prices continue?

International price trends and economic conditions will remain the significant determinant of inflation in coming months. Last year, international prices made high inflation tougher to tackle for policymakers. This year, with global demand projected to remain tepid, the trend of benign commodity prices is expected to cause the wholesale price index to contract for a few more months. Global oil prices are down in May to $75/bbl from about $ 83/bbl in April. The high base from last year will also support the downward pressure on inflation. Manufactured goods inflation is, therefore, unlikely to flare up.

Food prices could still upset the expectations of benign wholesale price inflation. Currently the chances of that happening are relatively low, despite worries about the rising price of wheat.

Going forward, the monsoon will be the big determinant, more so as prices of foodgrains are still not cooling despite the government’s measures last year – such as export restrictions – aimed at increasing supplies. Prices of paddy and pulses could be spoilers. It’s clear that besides taking steps to cool market prices year to year, the government will need to encourage farmers to increase the production of pulses. It’s not that such responses have been missing, but more needs to be done on the supply side. (Restrictions on exports do help lower market prices for consumers but also discourage production by farmers by distorting market signals.)

The RBI’s monetary policy committee is scheduled to meet from 6 to 8 June, and could be expected to glance at the WPI data. At its previous meeting the committee had held rates constant after raising the repo rate by a cumulative 2.5 percentage points over the previous 11 months. It is likely to remain in pause mode as CPI inflation also slowed to an 18-month low of 4.7% in April from 5.7% in March. The deflation in WPI that is likely to persist in the coming months is unlikely to make a difference to this pause. The RBI’s projections show it expects CPI inflation to ease in the first quarter of the fiscal year but pick up after June. It’s therefore too early to declare an end to the battle against inflation.