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Tale of 2 indices: Why CPI is headed north and WPI south

By R Jagannathan

Something interesting was done yesterday by the government. We got both the price indices on the same day within a few minutes of each other, but with the two - the Wholesale Price Index (WPI) and the Consumer Price Index (CPI) - pointing in different directions.

While the WPI for December declined to 7.18 percent, the CPI soared to 10.56 percent.

My (unsubstantiated) suspicion is that the government decided to issue both so that we can look at the more hopeful index - the WPI - on which depends the Reserve Bank of India's rate cuts on 29 January.

With one eye cocked at the WPI and the other at the CPI, we are on course for a 25 basis points (100 basis points equal 1 percent) cut in the repo rate on 29 January. AFP

And even here the government may have done some timing tricks. The CPI and WPI were timed for release differently, with the former coming in early and shocking the markets, and the latter coming in a few minutes later to lift spirits. The market got the message, hitting new highs.

The two indices are released by different ministries: the CPI by the ministry of statistics and programme implementation (Mospi) and the latter by the commerce and industry ministry.

However, even without any conspiracy theory, the point to note is that the two indices are telling us the same thing in some areas, and different things in others.

The two indices are giving us similar stories when it comes to food inflation - which is rising in both CPI and WPI. Both are in double-digits (13.1 percent and 10.4 percent respectively).

But the indices say different things about core inflation (ie, non-food, non-fuel inflation). While core inflation is falling in the WPI (down from 4.5 percent in November to 4.2 percent in December), in the CPI core inflation is stubbornly high at 8.4 percent. It has refused to budge from November.

The question is: which one will the Reserve Bank of India (RBI) consider when setting its new rates on 29 January?

Normally, the WPI is given higher weightage since it measures inflation more broadly across the economy, whereas CPI inflation is specific to consumers. But CPI inflation cannot be ignored when it is so high and rising. It is CPI inflation that sets the trend on inflationary expectations for the aam aadmi - and impacts demands for wage hikes, etc.

Why are the indices telling us different stories, and what do they tell us about which way they may head in future?

The WPI is weighted roughly 65 percent in favour of manufactured products, and 20 percent for food and primary products and 15 percent for fuel and power.

It is trending down because the industrial slowdown (the IIP was a negative 0.1 percent in November) is making it tougher for manufacturers to pass on cost increases. This is why core inflation is down.

The CPI is weighted differently - nearly 50 percent (approximately) towards food (including beverages and tobacco), 10 percent each towards housing and fuel, and the rest for miscellaneous items.

So if food prices are rising, and fuel prices (diesel, LPG) are to follow, they will impact the WPI and CPI differently. Food will impact CPI harder, while fuel will impact WPI more in the first round. Its second round impact on manufacturing will be muted due to the industrial slowdown. But fuel and power hikes will impact food prices, more so in an election year where governments will want to secure the farm vote by raising food procurement prices.

So if we are to assume the following events in 2013 - rising fuel prices, rising food prices, and higher taxes - one could predict that the WPI will start moderating faster than the CPI after rising in the initial months.

The government will thus want the RBI Governor to look at the WPI and not the CPI this month - and also in the rest of 2013.

As things stand, with Subbarao now in lameduck category - his term is due to expire in September - a slow reduction in interest rates is a possibility.

With one eye cocked at the WPI and the other at the CPI, we are on course for a 25 basis points (100 basis points equal 1 percent) cut in the repo rate on 29 January. For the year as a whole, a one percent cut look likely, but a lot would depend on the severity of the slowdown.

But one thing is sure: we are all going to pay more for staples.