What WPI deflation means for Budget 2015: Jaitley must go full-tilt for growth

The drop in the Wholesale Prices Index (WPI) for January 2015 to a negative figure of -0.39 percent suggests that the back of stubborn inflation has probably been broken. It does not mean that prices will not spike in future due to demand-supply mismatches in (domestic) food or (global) fuel, but the underlying inflationary potential is clearly dying.

This fact is buttressed by the fact that core inflation (non-food manufacturing inflation) is down to 0.9 percent, lower than December’s figure of 1.5 percent. Clearly, the manufacturing sector is down if not out, and has significantly lower pricing power.

While it is fair to say that January’s WPI has undershot estimates due to the sharp fall in fuel prices (-10.69 percent), the fact is this fall is even without the beneficial effect of the base effect – the WPI was bottoming out last January, and then started rising consistently till August 2014.

What this implies is this: even if fuel and food prices rise (but do not gallop), the base effect will ensure a benign WPI figure at least till August till when the base effect lasts.

No one should be surprised if we have another month or two of negative inflation. I had predicted some time back (read here ) that we could have negative inflation anytime between March and September 2015, but this has happened two months in advance due to the sharper-than-expected fall in global fuel prices.

Retail inflation, though, is the joker in the pack. Last week, using the new Consumer Prices Index (CPI), we saw inflation rise to 5.11 percent from 4.28 percent in December. Since Reserve Bank Governor Raghuram Rajan looks more at CPI than WPI for deciding interest rates, it means the negative WPI will be discounted by him. So no rate cuts are likely before April, unless the Union budget manages to surprise him on the positive side.

Rajan is, of course, entitled to his view. In any case, growth is not going to revive just because he cuts the repo rate by 0.25 or 0.5 percent in the next six months. Not when banks are still trying to blot the red ink from their loan books, and companies are trying to do the same on their balance-sheets by deleveraging.

So the best thing Finance Minister Arun Jaitley can do is to let Rajan  focus on what he needs to do. It is not necessary for North Block and Mint Street to have the same view on inflation and growth. The job of reviving growth is Jaitley’s - and Jaitley’s alone – at this juncture. Rajan should be free to join the party when he chooses.

Here’s what Jaitley should do.

First, the budget should kickstart public investment in infrastructure in a modest way in 2015-16, and in a big way the year after. This means Rs 50,000-1,00,000 crore this year, and twice that amount in 2016-17.

Second, he should avoid making the same mistakes made by all finance ministers every year: which is to start all non-tax revenue raising measures towards the end of the year. I can’t for the life of me figure out why disinvestment needs to happen only after October, and why all spectrum and coal auctions need to be bunched between February and March. All these money-raising avenues should be tapped all through the year.

Third, Jaitley needs to take the right message from WPI and CPI. The 5.5 percent gap between the two (5.11 percent for CPI and -0.39 percent for WPI) represents the sheer inefficiency built into the economy. If we take WPI to broadly represent producer prices and CPI final consumer prices - I am oversimplifying here, but this is a broad point one needs to make - then it means two things: there is huge value lost in reaching products from factory to consumer; this can only be remedied by eliminating inter-state market barriers and improving the supply chain. The goods and service tax (GST) will eliminate some of these inefficiencies and bring more tax revenues, but more attention needs to be paid to creating a single national market for all goods and services. The states have to be roped in to eliminate these barriers.

Fourth, Jaitley simply needs a more sensible fiscal deficit roadmap. It makes no sense to draw up a mathematically rigid deficit roadmap than mandates a 0.5 percent reduction every year regardless of the state of the domestic economy, global economic conditions, or the stage of the business cycle we are in. Fiscal deficits can be met only if tax and spending targets are realistic, and these depend on all the above factors. The most sensible way to make a fiscal roadmap is to state it in a range – where the lower range will be met if growth and inflation are in an expected range, and the upper range if growth falters.

The one-line message to Jaitley is thus simple: go for growth. Forget about what Raghuram Rajan is up to. The WPI is saying that growth is in trouble; the CPI is merely adding that there are gross inefficiencies in the system that bloat prices at the consumer end. The latter needs a different remedy.