Inflation indicators CPI, WPI should change simultaneously

R JagannathanFirstpost.com

It is difficult to think of a time when the two primary indicators of inflation – the Wholesale Price Index (WPI) and the Consumer Price Index (CPI) – told such different stories. One of them is clearly redundant, if not misleading.

In February 2015, the CPI clocked in at 5.37 percent while the WPI reported a negative number of -2.06 percent. This is a whopping 7.43 percent gap between wholesale and retail inflation. It either means the two indices are measuring two completely different things, or that the supply chain inefficiencies have worsened to a degree where wholesale and retail prices have no connection to each other.

Between January 2012, when the old CPI was released with 2010 as base year, and this year, the divergence between WPI and CPI was never as large as 7.5 percent. Now, with the CPI changing once again in just two years, WPI and CPI are on two different planets.

Even worse, at a time when the WPI has been falling for four months (November 2014 to February 2015), being negative every month, the CPI has been heading north consistently, from 3.27 percent in November 2014 to 5.37 percent in February. WPI, in contrast, has headed from -0.17 percent to -2.06 percent.

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Translated, this means that the inflation you and I face while buying from the market is rising, while inflation at the wholesale level is falling. In fact, at the wholesale level, we have deflation (assuming this trend continues).

One calls for interest rates to be held steady; the other calls for a sharp cut in rates, to avoid the possibility of a negative deflationary spiral. Of course, the RBI is watching the CPI, and so one wonders why the WPI should even be published. For whose benefit?

As already noted, the sharp divergence can theoretically be explained by one or two factors: One, it means there is increasing inefficiency in the supply chain between wholesaler and retailer. It means middlemen are making gains at the expense of the farmer, the manufacturer, and the consumer.

If this is true, the policy priorities should be to eliminate all barriers to goods movement within India, create one national market, improve infrastructure, and open up the retail sector.

The other explanation could be that either the CPI or the WPI is not capturing what it should. At least one of them is seriously outdated or wrong. One of them needs to be scrapped. Since the CPI is of recent vintage, and presumably more carefully weighted, it is the WPI that needs junking.

The latest CPI has been reworked using 2012 as base, with many new items added to the list of commodities. While the number of items used to calculate rural inflation has increased from 437 to 448, for urban consumers the items in the CPI have gone up from 450 to 460. Also, the new index gives less weight to food and fuel, and more to clothing, footwear and bedding – which suggests that as incomes rise, people spend less on food.

On the other hand, the WPI index is calculated on the 2004-05 base – well before the consumer’s basket of purchases changed substantially during the UPA years. As the UPA pumped money into rural areas and increased minimum support prices for food, the rise in rural incomes changed purchase patterns. For example, from basic staples like rice and wheat, people started buying more protein-based foods like milk, eggs, vegetables, meat, and poultry products.

If CPI has been changed this year to a new base, logically the same thing should have been done to WPI too, but the government has been slow in doing this.

This year has seen the government change many methods of calculation, and not merely CPI. In January, the Central Statistics Office changed the method of calculating GDP from factor cost to gross value-added. This has had the net effect of raising 4.7 percent GDP growth (under the old method) to 6.9 percent in 2013-14. This year could be even higher at 7.4 percent.

The reality is that companies are making lower profits, industrial production is low, exports may be stagnating, and banks have seen bad loans rising to Rs 3,00,000 crore. How can GDP look so healthy in this scenario?

Something clearly is wrong somewhere. This does not mean the new GDP calculation method is wrong, but till we know what the GDP was for the previous 10 years using the new methodology, we won’t know why GDP is suddenly showing an upturn from 2013-14 when the other indicators are down.

Similarly for CPI and WPI. The new CPI is available only for a very short period, while the old WPI is available for nearly 10 years. We can thus neither say anything about where consumer inflation is headed, nor whether wholesale inflation is really negative.

As a result, the Reserve Bank of India will be wondering whether to lower interest rates or wait till more data is available. If one looks at the WPI, it seems as if prices are crashing – which is closer to the ground reality reported by the Index of Industrial Production, bank bad loans and stagnating exports. The CPI says the opposite – that prices are firming up, especially in food and fuel.

While one is right? No one can be sure. The only thing that can be said is that when revisions are made, the government should make the new series of indices available for a long period so that analysts can compare what has really changed. And when CPI is changed, the WPI should simultaneously be changed.

2015 has seen too many data changes that make it impossible for analysts to figure out whether the economy is coming or going. Time to clean up our statistical act.

The writer is editor-in-chief, digital and publishing, Network18 Group