Stubbornly high inflation has for long beguiled Indian policy-makers. Now there’s an added dilemma: The two main inflation indexes are painting different pictures about price trends in the country.
Most global central banks look at inflation in consumer prices to make their interest-rate decisions. The Reserve Bank of India, by contrast, has traditionally based its monetary policy on the wholesale price index (WPI). But the WPI doesn’t capture movements in the prices of services, which constitute close to 60% of India’s economic activity. So in 2011 the bank introduced a consumer price index (CPI) to better reflect household expenses. The idea was to eventually phase out the WPI.
For now, though, the bank tracks both indices, and these are now throwing out divergent data. Inflation measured according to the WPI increased in August to 6.1% from 5.8% in July. The CPI, however, fell to 9.5% from July’s 9.6% reading.
The divergence was due mainly to differences in food prices in the two indexes. According to the WPI, food-price inflation spiked to 18.2% last month, while the CPI showed it declining to 11% over the same period. Food represents half of the CPI basket, but only 14% of the WPI index.
Pronob Sen, the government’s chief statistician, told the Times of India the discrepancy is because food prices are calculated differently in the two indexes. The CPI uses a weighted average between the market price and the price in the public distribution system (PDS), a system of state-run stores that sell basic essentials. The WPI, however, reflects only market prices. “The PDS price is constant so it tends to pull down the CPI food inflation,” Sen said.
But that explanation hasn’t convinced economists. In a research note, analysts at State Bank of India, the country’s largest bank, wrote:
“This trend of WPI higher than CPI in respect of food items is intriguing and is a trend against normal price behavior and needs to be examined more carefully, as it may have some important policy ramifications.”
Experts say the way forward may be to shift the central bank’s inflation anchor from the WPI to the CPI. The new governor Raghuram Rajan, has already hinted that he may be in favor of speeding up the switch by announcing that the bank plans to issue bonds indexed to consumer prices, which would be aimed at retail investors.