October WPI inflation falls sharper than expected to 8.39%

The CPI (retail) inflation has fallen just 102 basis points from the peak, despite the RBI hiking rates by 190 basis points. However, the impact of the rate hikes is visible in the wholesale price index (WPI) inflation.

November 15, 2022 9:49 IST | India Infoline News Service
Between February 2022 and May 2022 wholesale price inflation (WPI) had surged 320 bps from 13.43% to 16.63%. In contrast, between May 2022 and October 2022, WPI inflation fell sharply from 16.63% to 8.39%; a fall of 824 basis points.

Data Source: Office of the Economic Advisor

What is special about October 2022 is that WPI inflation has now fallen back into single digits after a gap of 18 months. The last time, WPI inflation was in single digits was in March 2021, at a relatively subdued 7.89%. The reality is that WPI inflation has shown perfect negative correlation with RBI hawkishness. Consider this causality. Between May 2022 and October 2022, the RBI hiked repo rates by 190 basis points from 4.00% to 5.90. During the same period, WPI inflation fell 824 bps from 16.63% to 8.29%.

The special meeting of the MPC (to explain the inflation overshoot to government) in early November 2022 also emphasized that the rate hikes would first translate into a fall in WPI inflation, followed by a fall in CPI inflation. It remains to be seen if this second level causality works out. In May 2022, WPI inflation had touched a 31-year high level of 16.63%. WPI inflation worsened in 2022 due to the Ukraine war, impact of Russia sanctions, China’s zero-COVID lockdowns and global central bank hawkishness.
Good news is WPI inflation has fallen across the board

The sharp fall in WPI inflation has been literally across the board. Manufacturing inflation yoy fell from 7.51% in August 2022 to 6.34% in September 2022 and to 4.42% in October. Since manufacturing has a weightage of 64.23% in the WPI basket, it had the highest impact on depressing the WPI number. Food inflation and energy inflation have also been tapering amidst a global commodity correction. While food inflation has fallen from 10.06% to 6.48% in the last 3 months, the Fuel/power inflation has fallen from 35.03% to 23.17%.

The highest producer inflation in October 2022 was in potatoes at 44.97% followed by HSD 43.05%, petrol 25.02%, vegetables 17.61%, cereals 12.03% and paper products at 11.93%. The fall in inflation is visible across primary, secondary and fuel products. There have also been some commodities in the basket with negative WPI inflation for October 2022. Onions at -30.02%, vegetable oils at -6.99% and oilseeds at -5.36% helped to keep the overall WPI inflation in check for October 2022.

Capsule of WPI components over last 3 months

Commodity Set Weight Oct-22 WPI Sep-22 WPI Aug-22 WPI
Primary Articles 0.2262 11.04% 11.73% 14.74%
Fuel & Power 0.1315 23.17% 32.61% 35.03%
Manufactured Products 0.6423 4.42% 6.34% 7.51%
WPI Inflation 1.0000 8.39% 10.70% 12.48%
Food Basket 0.2438 6.48% 8.08% 10.06%
Data Source: Office of the Economic Advisor

The latest reading on WPI inflation is important for several reasons. In the earlier part of the year, inflation trend was set by higher crude prices. However, even after oil prices started tapering on recession fears, producer inflation in food and manufactured products stayed elevated. Now the fall has been across the board with lower manufacturing inflation being driven by lower input costs. In last one year, the cost of raw materials, power, transport and manpower went up sharply. That is normalizing. Manufacturing inflation can taper further.

Between July 2022 and October 2022, fuel inflation fell from 44.62% to 23.17%. This is on account of two reasons. Firstly, recession fears kept crude prices under check. Secondly, the government has asked oil marketing companies (OMCs) to hold retail prices of petrol and diesel to prevent higher inflation impact. The OMCs are losing tonnes of money each quarter and the government has to compensate them at some point. That is unsustainable. Also, the OPEC plus Russia now appears to be keen on holding Brent crude prices around $100/bbl and is willing to cut supplies. That could be a big challenge.
Our reading of high frequency WPI data for October 2022

While WPI inflation is generally presented YOY, the DIPP also presents a high frequency MOM picture to provide useful insights on the colour and direction of short term momentum. Unlike yoy WPI inflation, the high frequency data captures short term shifts and macro pressures a lot more effectively.

·         For October 2022, overall MOM WPI inflation at +0.26%, turned positive after 3 months of negative of WPI MOM reading. Short term momentum is now inclining towards the upside and that could be due to oil prices staying elevated. We are not talking about the direct impact but the trickle down impact of higher oil prices. If the US applies the brakes on its hawkishness and RBI follows suit, the macro optimism could push short term producer inflation to higher levels. That is something to be cautious about.

·         Where is the MOM pressure actually coming from. The fuel basket still has negative MOM inflation of -1.65% for October 2022. It has stayed negative for the last 4 months in succession. However, it must be remembered that oil prices are artificially fixed in India under government directions and is not exactly market driven. High frequency inflation in manufactured products also remained negative at -0.42%.

·         The positive pressure on high frequency WPI inflation actually came from the primary articles basket, including the food basket. If you look at the break-up of the MOM WPI inflation for the primary articles basket, crude oil and gas extraction prices have gone up as have the landed costs. Similarly, due to weak Kharif output, food prices also rallied 2.3% MOM. This was partially offset by lower inflation in minerals in October 2022.

MOM numbers capture short term trends better but they also tend to be vulnerable to short term base effects. Oil & gas could be the joker in the pack to watch out for.

Rate hikes are working, but time for RBI to change tack

RBI may be disappointed by the reaction of CPI inflation to rate hikes, but the 824 basis points fall in WPI inflation since May 2022 must have given them an iota of hope. They would have definitely showcased WPI inflation as an example of how inflation targeting was working, when explaining to the government why CPI inflation was still out of the RBI prescribed limits of 2% to 6%. On the flip side, sustained negative WPI inflation is not something to celebrate as it indicates pressure on demand. Currently, rural demand is under a lot of pressure and that is also being reflected in the form of lower WPI inflation.

Now for the policy part. RBI-MPC members like Jayanth Varma and Ashima Goyal are already in the (enough of rate hikes) camp. They want the RBI to go slow and let the impact of rate hikes to sink in. Most likely, the RBI may opt to implement one more rate hike of 50 bps and then wait in the side lines. The WPI data will give comfort to the RBI that rate hikes are working albeit with a lag. WPI inflation tends to be more sensitive to rate hikes and that is evident in the way it has fallen. However, this needs to translate quickly into CPI inflation transmission. For now, the RBI has the leeway to shift its language from inflation to growth in 2023, if not in its December policy.

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