Analysis | What does high WPI inflation mean for interest rates?

Reserve Bank of India Governor Shaktikanta Das.

On April 18, the government data showed that India's inflation based on the Wholesale Price Index (WPI) rose to a four-month high of 14.55 percent in March from 13.11 percent in February. With this, the WPI inflation has now been in double-digit territory for 12 consecutive months.

What is the significance of this data? Under the current approach, the monetary policy committee (MPC) tracks retail inflation for the purpose of policy formulation. No one gives too much importance to WPI numbers. But, there's more than meets the eye in the numbers.

The higher wholesale price inflation could prove to be a point of worry for policymakers. WPI index is dominated by manufactured products which have a weight of 64 percent in the index and are influenced by global factors to a significant extent especially in the current context.

“Hence the tendency of global prices increasing gets reflected more in the WPI than CPI. This number has been above 10 percent throughout the year and only part of the explanation is in the low base effect,” said Madan Sabnavis, Chief Economist at Bank of Baroda.

Thus, higher wholesale prices are bound to reflect in the retail prices too going ahead. “With the war unleashing another round of price increases of commodities, we may expect producers to further increase their final prices in case there is no let down in the cost spiral,” said Sabnavis.

Remember, inflation is already pinching the bottom of the pyramid as retail inflation has been on a persistently high path for quite some time. The poor suffer in particular as this segment is already hit by income losses during the pandemic.

On April 12, official data showed retail inflation jumped to a 17-month high of 6.95 percent in March from 6.07 percent in February driven by high food prices. The Consumer Price Index (CPI) inflation print for March is well above the consensus estimate. As per a Reuters poll, economists had expected CPI inflation to rise to 6.35 percent.

The latest inflation print confirmed the MPC assessment that persistently high inflation is a bigger worry for policymakers going ahead. The MPC has a mandate to keep inflation in the 2-6 percent band and a breach of three consecutive quarters will require the panel to explain to Parliament why it failed to keep inflation within the band.

Sooner than later, higher wholesale prices will reflect in the retail prices.

What is even more worrying is the broad-based nature of WPI following the spike in commodity prices amidst the escalating Russia-Ukraine conflict. The broad-based nature of the rise in the WPI inflation is likely to be of particular concern to the MPC. To get a perspective, let’s look at the WPI internals. Manufacturing prices rose by 10.7 percent on a year-on-year basis, while inflation in the fuel and light segment stood at an elevated 34.5 percent year on year.

Supply shortages and higher prices in a number of input goods across metals, fertiliser and some food products could pose upside risk to domestic prices. Overall, core WPI inflation increased to 10.9 percent on a year-on-year basis in March from 10.0 per cent y-o-y in February. “We see a growing probability of the first repo hike being preponed to June 2022.” Said Adity Nayar, Chief economist of ICRA.

To sum up, although WPI print has no direct significance in MPC’s decision making (essentially because of the focus on CPI), the sharp and consistent increase in the WPI is likely to put more pressure on the MPC to reverse the rate cycle, perhaps, earlier than planned.