The Monetary Policy Committee (MPC) of the Reserve Bank of India RBI echoed a sentiment of cautious optimism by opting to keep the repo rate at 4%. Notably, this sentiment was also reflected in the Economic survey as well as the announcement of the budget.
As growth rates rebound from the effects of the pandemic, the RBI forecast a real GDP growth rate of 7.8% for 2022-23. On the other hand, the Survey predicted a real GDP growth rate of 8 to 8.5%.
While this certainly sounds like good news, inflation – especially the Wholesale Price Index (WPI) – can play spoilsport and the actual outcome can deviate significantly from forecast due to volatility alone. of the WPI. The GDP deflator, known as the overall economy-wide price index, is a derived indicator. Various components and sub-components of nominal GDP and their subsequent conversion to real GDP use different price indices.
In their current form, these conversions are heavily influenced by movements in the WPI and CPI. Therefore, achieving a particular real GDP growth target depends on achieving desirable levels of CPI and IPW inflation. In this context, it is important to understand the recent divergence between WPI inflation and the CPI.
For its 2022-23 outlook, the RBI’s MPC statement argued that “potential rising input costs are a possible risk, especially if international crude oil prices remain elevated.” So far, wholesale price inflation—which is a rough measure of input cost inflation—continues to remain high. It hit a three-decade high of 14% in November 2021, even as CPI inflation remained in the upper range of the target zone.
A closer look at the WPI reveals that all of its subcategories reflected high inflation throughout the third quarter of 2021-22. Of these, manufactured goods contributed an average of 47% to observed inflation. In addition, fuel inflation showed the strongest growth. For example, High Speed Diesel (HSD) – which is the wholesale term for diesel – increased by 86% in the month of November 2021.
Why has there been a steady rise in wholesale inflation (Chart 1), even though retail inflation remains relatively moderate?
Part of the double-digit inflation in the WPI can be explained by the presence of large “base effects” that have resulted from the pandemic. Note that “base effects” are not necessarily a statistical artifact. Buyers face different relative price pressures at different times, which has a differential impact on welfare.
A quick look at WPI and CPI inflation after March 2020 reveals that the WPI remained in the negative zone for an entire quarter after the first lockdown, unlike the CPI which recorded positive inflation constant. WPI subcategories showed a similar trend, with wholesale prices for food, manufactured goods and fuel remaining under control throughout the pandemic.
Therefore, as the WPI recovers from its 2020 low, base effects are sure to set in creating a high inflation figure. However, base effects alone do not explain what is effectively also a “wholesale price catch-up” to their retail counterparts. At the basic pairing element, there should not be much variation as both reflect changes in price ratios.
Chart 2 shows the inflation for the elements common to the CPI and WPI indices. These elements represent 73% of the CPI index and 34% of the WPI index.
It can be observed that with the exception of the pandemic period, the wholesale and retail price inflation of these goods follow each other closely. Over the past quarter, wholesale price inflation for these similar items has begun to outpace retail price inflation. This indicates the possibility of higher wholesale prices even if base effects dissipate.
Effect of rising WPI
Given that the RBI’s position depends on low CPI inflation, what would be the effects of a sustained rise in wholesale prices? First, there would be an impact on CPI inflation. This could lead to CPI inflation exceeding the 4.5% forecast for 2022-2023.
Second, it could lead to downward corrections in real GDP projections due to the rise in the CPI itself. Along with that, juxtapose the possibility of higher WPI inflation. For example, assuming a projection of nominal GDP growth of 11% with a projection of real GDP growth of around 7-8%, one could arrive at inflation based on the GDP deflator of around 3-4% .
However, if WPI inflation continues to stay in double digits, we cannot expect inflation based on the GDP deflator to stay below 4%. Therefore, while aiming for CPI inflation of 4% is consistent with achieving the RBI’s inflation target, it is not enough to achieve its growth target unless WPI inflation does not. is also contained at a lower level.
Given growth considerations, it makes sense to hold interest rates for the time being. However, the effects of high wholesale price inflation are significant and can lead to more gloomy projections for the economy.
Meera is a research associate and Abhiman Das is a professor of economics at IIM Ahmedabad.
February 13, 2022