Divergence between the wholesale price index (WPI) and consumer price index for industrial workers?CPI (IW)?has raised questions on the validity of measure of inflation. In recent months, while WPI showed inflation close to or just above zero, CPI (IW) recorded double-digit growth. A colleague from Icrier, speaking at a seminar on the state of the macro economy recently, was unable to decide whether to describe the situation of violently diverging indices as a comedy or a tragedy!
The Cabinet decision to revamp WPI is therefore not a day early and very welcome. The shortcomings of the WPI are well known?incomplete product composition (services are excluded), outdated base year and a defective weight structure. Although WPI?s coverage is superior to CPI (IW) in terms of the commodity basket, measurement of inflation using WPI has come in for serious criticism in the last one year.
On October 19, the Cabinet Committee on Economic Affairs (CCEA) approved the commerce and industry ministry?s WPI revamp proposal, which was based on the recommendations of a working group headed by Abhijit Sen, member, Planning Commission. The proposal is to convert WPI into a monthly series using 1993-94 as the base year instead of the current practice of weekly reporting. This is similar to the situation in the US and UK.
Price data on manufactured products subgroup will henceforth be released monthly in tandem with the release of WPI. In addition, a price index for primary articles and commodities in fuel, power, light and lubricant group would be compiled and reported on a weekly basis to facilitate monitoring of prices of agriculture commodities and petroleum products over a shorter interval. The proposal also carries important changes that are likely to be implemented later, namely expansion of the commodity basket from 435 to around 900 and change in the base year to 2004-05 from the existing 1993-94. Change in the base year and expansion of the basket will naturally alter the weight structure of the subgroups within the WPI. For now, the data on overall WPI will be released on 14th November, with 1993-94 base year and with the old commodity basket.
The expectation from this change is that WPI will now reflect underlying inflation better and also help in narrowing the divergence between the two indices to some extent. WPI comprises three major groups, namely primary articles, manufactured items, and fuel, light, power and lubricants, contributing 22.02%, 63.75% and 14.23%, respectively to overall inflation. Manufacturing is the biggest subgroup and thus movements in WPI inflation closely follow those in the manufacturing.
The proposed changes in the WPI series with its focus on manufacturing have several implications. First, only 16-20% of the WPI items in the manufactured group are updated weekly. For the rest, data is the same as reported in the previous week as companies often do not report price data on a weekly basis. This implies data reported by WPI is based on only 20% items in manufactured group and could be one of the strong reasons for low inflation for manufactured products.
Second, shifting the frequency of price index from weekly to monthly will smoothen out the short-term volatilities in WPI. The figure above shows weekly volatilities, measured by standard deviation, in three major groups of WPI.
During the phase in which the world economy was in recession, from June 2008 to February 2009, fuel prices were highly volatile as were primary articles. These prices are more prone to shocks and the impact is visible in the numbers almost immediately. On the other hand, manufacturing price changes often occur with a time lag. As a result, fluctuations in manufactured group are visible from March 2009 onwards.
The monthly release of WPI would come at a price however. It is reported that data for a specific month will be released with a lag of about eight weeks from current practice of two weeks. The producer price index (PPI) of the US reports more than 9,000 PPIs for individual products and group of products every month for which more than 1,00,000 price quotations are collected. The US data is available with a lag of less than a month. The time gap in the release of WPI needs to be reduced over time to make the policy formulation more effective and fast.
The shift to a monthly series is welcome. It will increase the accuracy of the data and reduce volatility between the provisional and final data. The Cabinet decision to report highly volatile groups?fuel and primary articles?weekly is also useful to the extent that it provides early warning signals for the likely movement of WPI. This is the first step, albeit a small one, towards correction of WPI. Other major changes are required to make the index equivalent to PPI. These include expansion of commodity basket and inclusion of services, change in base year and revision of weight structure. The good news is that these changes are in the offing.
?The author is research associate at Icrier & research scholar at JNU