The inflation mismatch

Retail and wholesale inflation divergence creates policy dilemma

The government data on Monday showed that inflation based on the wholesale price index rose 3.58 per cent in December. Not only was this lower than what most observers expected, but also lower than the wholesale inflation for November, which was 3.93 per cent. The key factor that led to a lower imprint was the fall in food prices — fruits and vegetables in wholesale markets have become 14 per cent cheaper than in November. As a result, wholesale food inflation decelerated to 4.72 per cent in December from over 6 per cent in November. However, in sharp contrast, inflation based on the consumer price index, or retail inflation, for December rose to a 17-month high, according to data released on Friday. Thanks to higher food and fuel prices, as well as an unfavourable base effect, retail inflation accelerated to 5.2 per cent in December. It has risen sharply since October, when it was 3.58 per cent, and November, when it was 4.88 per cent.

What makes these two sets of data particularly important is their timing: These are the numbers that Finance Minister Arun Jaitley will have as he finalises calculations for the Union Budget on February 1. It is possible that the divergence in wholesale and retail inflation may be bridged as wholesale prices of food, especially fruits and vegetables, are showing the impact of fresh supplies arriving the market in December. This cushion may show up in the softening of retail prices as well in the coming months. For instance, the surge in the prices of vegetables such as onions and tomatoes has bumped up retail inflation in a sustained manner for most of the second half of 2017.

However, there are several reasons to worry about retail inflation as it is the variable that is targeted by the Reserve Bank of India (RBI). In its last policy, the RBI’s Monetary Policy Committee decided to stay put, instead of cutting the repo rate, primarily because it was concerned about the inflation trajectory. In fact, it raised the retail inflation forecast for the rest of the current financial year to 4.3-4.7 per cent. It did so recognising the spurt in global crude oil prices as well as the effects of the Seventh Pay Commission recommendations. The December data corroborates these concerns: Inflation in vegetables soared to 29 per cent, while housing inflation, following a higher house rent allowance to government employees, rose sharply to 8.2 per cent. The threat from higher oil prices, while not materialising in full measure in December, will continue to be a significant one.

In sum, far from the expectations of an interest rate cut, it would not be far-fetched to expect some of the more hawkish voices within the RBI’s Monetary Policy Committee to consider a rate hike when it reviews the policy on February 7. But in light of the gap between wholesale and retail inflation, it is worth asking whether the central bank should be targeting retail inflation. That is because retail inflation has a huge component of food and fuel prices, both of which are driven by exogenous factors and as such are beyond the reach of monetary policy. In contrast, wholesale inflation, which has a much higher weight for manufacturing, something monetary policy can impact, is trending much lower.