The saga of Wrong Price Index

The Indian inflation scenario is dotted by two indices: Wholesale Price Index (WPI) and Consumer Price Index (CPI). While WPI is the price of a representative basket of wholesale goods (also called headline inflation), the CPI is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care (also called retail inflation).

But there is a catch here. They are moving in divergent directions. In the last eight months, while retail inflation has consistently moved upwards, the headline inflation has dramatically contracted, leaving a gap between these two inflation estimates.

In 2010-12, WPI averaged 10%, coming down to 7% in 2013, while CPI stayed between 9% and 11% during these years. In the last five years, WPI has fallen sharply to 4% in July 2015, while CPI has moderated to 4% during this period, and now stands at 5.5%. The gap between the two went up to almost 7% at peak in the last one year.

“No country in the world uses WPI. We used it because it was convenient, because it was available,” says Raghuram Rajan, Governor of the Reserve Bank of India (RBI). Rajan is credited with bringing the inflation down in India.

“But the truth is that the man on the street faces CPI. So we can’t pick the WPI only because it is lower,” opines Rajan.

“It turns out that WPI is lower because commodities in the world are falling in prices and therefore have held the wholesale price index down. I have no doubt as the commodity prices pick up, the WPI inflation will pick up. At that point, all those people who are saying let’s move to WPI, will say let’s move to the CPI. You can’t pick up the index that you want. Ulimately, you have to pitch the index that is relevant,” says Rajan, negating the need for having an index for headline inflation.

Highlighting the importance of CPI, Rajan goes on to add, “From the perspective of an individual, of the household, of the customer, of the citizen, it is the consumer price index. That is what they see, that is what they eat, that is what they live.”

‘WPI can be misleading’
Rajan’s thoughts are seconded by M Govind Rao, Member of the 14th Finance Commission. “I agree with getting done with WPI because it can be misleading. WPI doesn’t really represent the price index that one should consider,” opines Rao.

“If you really want to know the production prices, then you will have the GDP deflator,” he asserts. The GDP deflator (implicit price deflator) is a measure of the level of prices of all new, domestically produced, final goods and services in an economy. GDP stands for gross domestic product, the total value of all final goods and services produced within that economy during a specified period. India’s GDP deflator stood at 1% in 2015, down from 3.3% in 2014, as per the data available with the World Bank.

 “The weights assigned to different commodities in the WPI is different from that of the CPI,” Rao goes on to add. “In WPI, prices at the production stage are taken into account and that is not based on the consumption basket, but on production basket. Whereas in case of CPI, the weights are based on consumption basket. So, as such, lot of WPI has got to do with imported prices like crude. And CPI is mostly equivalent to domestic consumption price,” he adds.

Rao’s argument on the different weights assigned is seconded by Rajan Govil, Managing Director, Marketnomics.

“The difference arises out of the fact that different weights are assigned to various elements in both the indices,” says Govil, who was formerly an economist with International Monetary Fund (IMF).

But Anurag Sharan, Managing Director of Southern Fidelity Securities, is very critical of Rajan in this case.

“Immediately on taking over as RBI governor, Raghuram Rajan overturned the long-held government policy of keeping WPI as the central measure in inflation-based targeting of monetary policy or interest rates and substituted CPI or consumer price index,” says Sharan.

“At that time, it seemed a small measure, as the two indices were normally within 1-2% point of the other in the preceding 10 years. The nomenclature itself suggests that the two should converge within a gap of a few months at most, translating into consumer prices, profit margins of middlemen and others remaining constant. But in fact, the two are entirely different indices, capturing different aspects of the economic environment. Thus while CPI has greater weightage on food and beverages, as also services, has additional 10% on housing, WPI leans towards commodity prices of industrial/manufactured goods. It’s almost like comparing apples with oranges,” he adds.

Talking of this difference, the role of middlemen can’t be ignored. Indian markets are dotted by a culture of ‘mandis’. These ‘mandis’ along with the middlemen are a very unregulated market.

They do add to inflation by notches. It is the right time for the government to regulate them.
So, is the WPI, that is used to measure the headline inflation, a Wrong Price Index rather than Wholesale Price Index. The sooner the question is addressed, the better it would be to avoid all ambiguity.