Four-Year High Wholesale Price Inflation

What is the issue?

The Wholesale Price Index (WPI) rose 5.77% on a year-on-year basis to a 54-month high in June 2018.
The inflation scenario demands a closer look at the macro-economic conditions.

What are CPI and WPI?

Both measure the inflationary trends i.e. movement of price signals within the broader economy.
WPI tracks year-on-year wholesale inflation at the producer or factory gate level.
It is a marker for price movements in the purchase of bulk inputs by traders.
Consumer Price Index (CPI) tracks changes in prices levels at the shop end.
It is thus reflective of the inflation experienced at the level of consumers.
The two indices differ in the manner in which weightages are assigned.
This applies to food, fuel and manufactured items as well as their sub-segments.
E.g. weightage of food in CPI is far higher (46%) than in WPI (24%).
Also, WPI does not capture changes in the prices of services but CPI does.

What are the driving factors for WPI rise?

Rising crude oil prices has persistently driven inflation.
Inflation in the fuel and power group has risen every month in the recent period.
Food articles, especially vegetables, have been on a rising trend as well.
The inflation in politically sensitive duo of potatoes and onions is a notable cause.
Manufactured products (largest weight in the WPI) are also on an inflationary trend.
WPI rise is also to be seen from the perspective of an unfavourable base effect.
It is the effect of the previous year taken as the base for calculation.
This is because the WPI inflation in June 2017 was just 0.9%.

Is WPI rise a concern?

Policy - In 2014, RBI had adopted CPI as its key measure of inflation from the earlier WPI.
India thus shifted to CPI as the benchmark for deciding policy rates (e.g. repo rate).
Accordingly, RBI has a target to keep consumer-level inflation at 4% (+/- 2%).
Any rise in CPI inflation beyond this comfort zone pressurises RBI to hike interest rates.
So WPI rise might not appear relevant from a policy perspective.
Economy - However, price changes at the producer level usually get transmitted to the consumers.
But this could come with a time lag or may not be to the full extent of the impact at the producer level.
So, the apprehensions with a higher WPI may not be valid at all times.
Nevertheless, a steady rise in WPI is certainly an indicator of an overall inflationary pressure.
It reflects the unbalanced conditions within the broader economy.
Retail - There is a concern of a cascading effect of WPI increase on the CPI.
This remains even after discounting for the base effect.
Evidently, the retail inflation (CPI) had risen to a 5-month high of 5% in June, 2018.

How does it affect growth?

Inflation-growth relationship is “significantly negative” if inflation is above a threshold value.
It is “insignificant or significantly positive” if inflation is below the threshold value.
Simply, inflation to a certain extent is favourable to the economy, above which it becomes harmful.
But generally, the threshold values in developing countries are relatively higher.
In India's case, roughly 4 to 5.5% inflation is said to be the range, above which it retards GDP growth rate.
But substantial gains can be achieved if inflation is kept below the threshold.

How does the future look?

Government has recently decided to increase the minimum support price for kharif crops.
A possible inflationary pressure due to this exists already.
On the other hand, inflationary trend has reinforced the expectations of a repo rate hike.
As, rate hike would be a measure of controlling the inflationary trend.

However, IMF in a recent update has said the Indian economy will grow slower than estimated earlier.
It has also cut India’s growth projection for 2018-19 by 10 basis points to 7.3%.
The pressure on growth due to the added impacts of inflation and faster interest rate hikes is the reason.
Thus, balancing between inflation and growth prospects would be a challenging task for the policy makers in the near future.

Source: The Hindu, Indian Express