June brought to the fore a rather curious turn in inflation — the reading based on the Consumer Price Index (CPI) rose to 4.8 percent from 4.31 percent the previous month, while that based on the Wholesale Price Index (WPI) declined to 4.1 percent.
This dichotomy is not new, though. Data for the past decade shows such a divergence occurred in 2015-16 and then in 2020, after the pandemic struck.
The way it works, WPI captures the movement of prices in wholesale markets and reflects the economy’s production structure, while CPI measures what consumers pay for goods and services.
Though it is true that consumer prices are invariably higher than wholesale prices, inflation measures the rate of change in prices, which cannot be explained solely by the type of markets they cover. Such dichotomy can, at times, be confusing.
WPI is more volatile than CPI and tends to swing between inflation and deflation. In contrast, CPI inflation has always been in the positive zone.
The difference in the composition and weightage of the two indices explains the bulk of the divergence in their inflation rates. WPI completely excludes the services sector, which constitutes over 50 percent of the economy, while CPI covers both goods and services.
CPI inflation is stickier, as services inflation is influenced by domestic demand and supply conditions. Inflation in services such as healthcare, education and personal care and effects was 6.2 percent, 5.9 percent and 9 percent, respectively, in June.
WPI, on the other hand, covers only goods and fuel, and is typically influenced by global price movements in a phenomenon often referred to as imported inflation.
For instance, after the pandemic struck, WPI inflation collapsed to -3.4 percent in May 2020, in line with the fall in global crude and commodity prices, which took a hit as economic activity stalled. It then shot back to 16.6 percent by mid-2022 with the resumption of economic activity accentuated by the force multiplier from the Russia-Ukraine conflict, which pushed up commodity prices.
Now, again, the correction in crude and commodity prices and the normalisation of global supply chains have dragged WPI down into the deflation zone.
The other reason for the divergence in WPI and CPI inflation is the weights assigned to different goods. In WPI, food items have a low weight of 15.3 percent for primary food products and 9.0 percent for manufactured food products (total 24.4 percent), while in CPI, food and beverages have a whopping 45.9 percent weight. As food forms a very volatile part of the price index, its behaviour leads CPI inflation to swing much more than WPI.
What does deflation in WPI mean for CPI in the current context?
Falling WPI inflation means lower input costs for the industry. This can help cushion the margins of companies and/or moderate the goods inflation part of CPI as pressure on the industry from higher input costs eases.
Currently, services are seeing a delayed and strong rebound, which is putting upward pressure on CPI inflation.
The big elephant in the room this year is the dynamic between monsoon and food inflation, which will influence CPI much more than WPI.
Thus, the divergence between CPI and WPI will continue, with CPI inflation printing higher than WPI in the current fiscal, in sharp contrast to what happened last year.
Besides the divergence, a key issue that plagues both indices is that their weights are based on an outdated base year of 2011-12. There is thus an urgent need to re-base the weights to a recent normal year as the structure of the economy and consumption pattern have changed. Outdated weights can also create a divergence between true and measured inflation and complicate policy-making.
The writer is Chief Economist, CRISIL
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