Opinion beyondbrics

India: CPI vs WPI, which to use?

Avantika Chilkoti SEPTEMBER 17, 2013

Here’s a growing dilemma for India’s policy makers.

According to the Wholesale Price Index, inflation picked up in the month of August to 6.1 per
cent from 5.8 per cent in July. On the other hand, the (newer) Consumer Price Index indicates
that inflation slowed in the same month, moderating from 9.6 per cent to 9.5 per cent.

Why the divergence? And which of these disparate measures should policy makers be looking at?

In a statement earlier this month, the former governor of India’s central bank, Duvvuri
Subbarao, explained the different between the two estimates:

To some extent, the divergence between WPI and CPI can be attributed to statistical
differences stemming from coverage, classification of items and the relative weights of their
constituents. However, there could be other reasons for this as well. For example, higher
transaction costs, taxes, etc. are reflected in the CPI but not in the WPI.

Food price inflation accounts for much of the gap between the two indices at the moment. In the
WPI, food inflation rose from 10.3 per cent year-on-year to 18.2 per cent in the quarter ended in
August. For the CPI, the same figure has declined from 11.7 per cent to 10.9 per cent.

Economists at State Bank of India described this as a “paradox”, noting that “an increase in food
prices should logically imply an increase in both [indices].”

The following chart – which looks at just the food component of the two inflation measures –
highlights the strange food price divergence.

This trend of CPI higher than WPI in respect of food items is intriguing and is a trend against
normal price behavior and needs to be examined more carefully, as it may have some
important policy ramifications.

Analysts at ANZ explained in a note to clients last month:

 We note that food represents half of the CPI basket (as opposed to 14% of the WPI, or 31% if
you include the less-volatile manufactured food items) and retail food prices are heavily
government influenced.

Indian policy makers currently pay most attention to wholesale prices – that’s what decisions
are based on and linked to. But perhaps that seems a bit odd, given it is consumer price inflation
that affects the Indian public.

Subbarao recognised that, though changes in wholesale prices should theoretically carry through
to retail prices, there is a lag in that process and the result could simply be a reduction in
suppliers’ margins.

His statement also noted that:

Several analysts have argued that the use of WPI inflation by the Reserve Bank is flawed on
the ground that in India, the WPI proxies producers’ prices rather than consumer prices.
Moreover, it is contended that WPI does not adequately capture the movement in the prices
of services, which constitute close to 2/3rd of our economic activity.

Case closed? Not quite. The CPI has problems too. Firstly, the indicator hasn’t been compiled for
the entire Indian population for long enough to provide useful historical data. Secondly, with the
CPI so sensitive to food prices, Subbarao believes the indicator may be dominated by supply side
factors. And a 10 per cent weighting for housing rents, where values are estimated, means the
effectiveness of the index is questionable.

The former governor of the RBI says the WPI can’t be abandoned overnight and the solution is
to develop a “producer price index” which will gauge how price pressures are developing.

There’s another one for Raghuram Rajan, the new governor of the RBI, to put on his (extensive)
to-do list.

Related reading:
Rajan enters RBI with a big bang, FT
Onion prices bring tears to Indian eyes, FT
Guest post: Rajan at the RBI – will his reforms work? beyondbrics

Get alerts on Emerging markets when a new story is published Get alerts

Copyright The Financial Times Limited 2018. All rights reserved.