The Wholesale Price Index (WPI) inflation released last Friday for the week ending 3rd July, 2004, came out at 6.16 per cent, less than reported market expectations of between 6.4 and 6.5 per cent. The world over it is customary for both central banks and market players to track the inflation in consumer prices indices (CPI), not producer prices ? which is what the WPI rate is about. In India, however, for a variety of reasons it has been WPI that for years has principally engaged attention. There is good reason for this. First, WPI inflation report comes out every week and is fairly current nowadays ? with a lag of only a fortnight. In contrast, the CPI inflation report is on a monthly basis and involves a lag of over six weeks. Second and more importantly, the WPI report provides a detailed commodity-wise break-up that helps us understand the analytical basis of the inflationary process. In contrast, the (published) CPI inflation report does not provide such disaggregated data, but has a wealth of stuff on inflation in 60-odd urban centres, which might be of utility in working out location-specific dearness allowances, but is not helpful in understanding the inflationary process per se.
Is this fact relevant? It indeed is, since monetary policy is to a great extent guided by inflation objectives (if not entirely so like in Europe and some other developed economies) and the interest of market players lies in anticipating such future moves. It would be inconceivable to expect of the Indian monetary authorities to ignore the CPI inflation, especially if there exists considerable variance with the WPI rate. Through much of the previous twelve months, while WPI inflation rate has ranged between 4 to 6.5 per cent, with an average of 5.2 per cent, the CPI inflation rate averaged 3.5 per cent. In fact, for April and May 2004, the CPI inflation rate for urban non-manual employees and industrial workers have both been well below 3 per cent, considerably lower than the counterpart WPI rate of 4.6 per cent. The CPI inflation rates for agricultural and rural labourers have been even lower.
There is an-other measure of inflation that is not commonly used ? that is the implicit GDP deflator. This obtained by combining the GDP estimates at current and constant prices and separating the real growth from the inflationary component. The implicit GDP deflator for 2003-04 was 3.7 per cent and that for the previous year was 3.5 per cent, somewhat closer to the levels of the CPI inflation rates, than to the WPI inflation rate.
This is not a situation restricted to India. For instance, in the USA the inflation rate that is widely used are the CPI rates for urban workers, wage earners and clerical workers. These rates have been rising, the market has drawn the implications of rate increases (along with evidence that the economy is growing and that extreme liquidity easing was outliving its usefulness), and the first of the rate hikes happened this June. The rates for May 2004 were about 3 per cent for both the CPI indices (compared to the index in May 2003), and this was perceived as a large increase from the 2 per cent levels seen up to early 2004. However, producer price inflation for finished goods has been much higher and was in excess of 5 per cent for the months up to May 2004, although in June it fell to 4 per cent. So while tracking the changes in the WPI, it is important to bear in mind what is the level of CPI inflation, and also keep abreast of the level of the implicit GDP deflator.
Why do WPI and CPI show so much difference in inflation? It has to do with the composition of the basket of things that make up the index. In the case of WPI the index is composed of manufactured finished goods & intermediates (64 per cent), commercial energy (14 per cent), primary food (15 per cent) and primary non-food (7 per cent). In the CPI basket, manufactures and energy have a much smaller weight, while food has a larger one; further services like house rents, education, medical care and purchase of transportation services also figure. Thus, when WPI and CPI move at a variance, the implicit GDP deflator is more reflective of the trends brought out by the CPI inflation rate.
Energy prices have been the principal factor roiling the inflation picture world wide, though food prices have played a subsidiary role. Thus, were we to exclude the direct impact of energy and food, the CPI inflation rate in the US in May 2004 would have been just 1.3-1.7 per cent for the two CPI indices. Energy inflation was 15-16 per cent and that for food 4.1-4.2 per cent in May 2004. A stronger euro has meant that rising crude oil prices have impacted Europe less. Even so, while in May 2004, the CPI inflation rate in the Eurozone (2 per cent is the central bank target) was 2.5 per cent, without food and energy it would have been 2.1 per cent.
In China after years of near zero inflation, prices started rising since October 2003, inspiring the policy move adopted early in 2004 to restrict the growth of bank credit. However, overall CPI inflation is currently close to 4 per cent, but reportedly if food and energy was to be excluded, the inflation in the balance of the index would be nearly zero per cent. It is worth noting that the direction of inflation ? measured by the most recent 3-month compounded rate ? appears to be headed towards softening in recent months. This would be a success of the policies adopted by the Chinese government to prevent over-heating.
Finally, the latest estimate of GDP growth in the US (3.9 per cent) for the first quarter of 2004 is lower than expectations (and the last quarter of 2003); the US trade deficit fell 4 per cent in May and producer price inflation was 1 percentage point lower in June 2004; the pace of Chinese investment seems to have been tempered.
All this points more to a likelihood of stabilisation, not further rise in the inflation rate in the near future, subject that is, to crude oil prices not again going out of control.
The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)