Measured CPI inflation may be already reflecting declining prices, or close to price stability
India’s WPI inflation entered the negative territory in November 2014 and has stayed in the red since then. At present, WPI inflation stands at minus 4.95%. CPI numbers, on the other hand, are possibly indicating much more, though the trend there is not as clear as with WPI numbers. With spike in May and June, CPI has again moderated to 3.78% in July 2015. Interestingly, a full blown debate has now erupted on whether the current situation reminisces a deflation or disinflation, in the aftermath of comments by the CEA.
By any stretch of imagination, we are not in a deflationary environment right now. Take, for example, the currency with the public. In August 2010—in the aftermath of the currency crisis—the year-on-year growth in currency with the public was at a sharp 21%, while currently it at 10%. Clearly, there is an appetite for increased spending forward, if we take this as an indicator. However, the counterpoint could be that people are postponing consumption in anticipation of further softening of prices. Interestingly, in 2010, the huge increase in currency could also have been attributed to less usage of plastic money, which has now increased significantly thanks to e-commerce. If this is so, the decline in currency could be just a by-product of a structural transformation within the economy.
However, I will be dishonest if I don’t admit that we may not be in a deflation but definitely in a situation of declining prices! Let me give five reasons for that.
First, contrary to popular belief, WPI inflation is not being driven only by the collapse in the tradable component part, as if we strip out this segment, WPI inflation was still in the negative territory at minus 2.2% in August 2015 itself.
Second, within core WPI, the domestic core is now at minus 1.21%, and the pace of decline has accelerated in the last couple of months. This indicates that corporate pricing power is low and is corroborated by the SBI corporate pricing index at minus 0.91%.
Third, on the CPI front, though the core of core CPI (core CPI excluding transport) is trending at 5.24%, we think a suitable to proxy to strip out the impact of fuel price decline is headline CPI excluding transport. This is because RBI is targeting headline CPI and not core CPI. This number is currently trending at 4.06%, nearly identical to RBI terminal CPI projection in 2018.
Fourth, excluding pulses, CPI is trending at 3.15%, a matter of enough comfort.
Fifth, although the monsoon rainfall is 16% below normal till date, yet the fear of high food prices and low foodgrain production is unfounded. Past trends indicate that we may have passed the worst, as generally food price increase takes place in July-September and decline thereafter as new produce comes into the market. Rainfall was 16% below normal in July and 22% below normal in August, but still food prices have actually declined in the July-August period.
I also have a small issue with the current CPI methodology, which may be subject to a variety of biases in India. A first source of bias can arise when shifts to lower price discount outlets are inadequately reflected. As all of us now understand, there are significant price discounts being offered by almost all retail outlets, and the moot question is whether we are capturing them in our CPI? The second element is that e-retailing, which comprises of online retail and online marketplaces, has become the fastest-growing segment in the larger market, having grown at a CAGR of around 56% over 2009-14. The size of the e-retail market is pegged at $6 billion in 2015. Books, apparel, and accessories and electronics are the largest selling products through e-retailing, constituting around 80% of product distribution. The increasing use of smartphones, tablets, and internet broadband and 3G/4G has led to a strong consumer base likely to increase further. So, there is a need to include the prices charged by the e-retailers to the customers while calculating CPI index, and if this is, there may be a downward bias.
The third element, the housing index, considers the average of rent relatives by classifying the dwelling living room wise (1/2/3/4 or more rooms). However, in the same locality there may be a different rent for the same type dwelling living rooms (1/2/3/4 or more rooms), which is based on the quality of construction, location, size and other facilities. So, in our view, the housing index may not be reflecting proper housing inflation in urban areas.
A fourth element relates to new or improved products, whereby prices included in CPI may inadequately reflect these products’ characteristics. The magnitude of the overall bias due to these factors varies across countries but is generally perceived to range between 50 and 100 basis points.
We tried to do a similar exercise for India. We compared the actual CPI numbers with Bloomberg CPI projections for a group of economists over the last one year. We found the projections were higher on an average by 50 basis points for the 18-month period ended July 2015. So, if we admit that there is a measurement bias, it is likely that measured CPI inflation may be already reflecting declining prices, or close to price stability.
Let me sum up by mentioning a small anecdote. In India, we have the unorthodox habit of stripping out volatile numbers from CPI/WPI to argue our case of a benign inflation scenario or vice-versa and hence the case for a status quo in rates or a cut. To this, my only answer is: “Torture numbers, and they’ll confess to anything”—Gregg Easterbrook.
Shambhavi Sharma & Tapas Parida contributed to this article
The author is chief economic advisor, State Bank of India. Views are personal