It may be recollected that 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 September 2022, WPI inflation has fallen sharply from 16.63% to 10.70%; a fall of nearly 600 basis points.

One can argue that the WPI inflation has now been in double digits for 18 months in succession. But that glosses over the fact that the WPI inflation has shown the perfect negative correlation with RBI hawkishness. Between May 2022 and September 2022, the RBI has hiked the repo rates by 190 bps from 4.0% to 5.95. During the same period, the WPI inflation has come down by 593 bps from 16.63% to 10.70%.

If one looks at the minutes of the RBI MPC meet, the analysis is that rate hikes would first translate into a fall in WPI inflation, followed by a fall in CPI inflation. We have to wait and watch as to how this process flows pans out in the Indian context.

WPI inflation has fallen and it is across the board

September 2022 marked the 18th consecutive month of double-digit WPI inflation, but it has now fallen below 11% for the first time since September 2021. That is significant respite compared to the 31-year high WPI inflation of 16.63% in May 2022. WPI inflation had then worsened due to Ukraine war, Russia sanctions, China lockdown and monetary tightness.



Data Source: Office of the Economic Advisor
Manufacturing inflation yoy has tapered from 8.24% in July 2022 to 7.51% in August 2022 to 6.34% in September 2022. Since manufacturing has a weightage of 64.23% in the WPI basket, it will surely keep overall WPI inflation in check and that is what we are seeing. Food inflation and energy inflation have also been tapering amidst a global commodity correction. However, on the energy front, the risks could arise from coal shortages, higher price of natural gas and the chance that the 2 million bpd supply cut by OPEC could spurt oil prices.
The highest producer inflation in September 2022 was in crude petroleum and natural gas at 44.72%, Potatoes at 49.79%, vegetables at 39.66% and wheat at 16.09%. Food basket remains a worry, although the pressure is visible more on the consumer side than on the producer side. There have also been some commodities in the basket with negative WPI inflation for September 2022. Onions at -20.96%, Oil seeds at -16.55%, vegetable oil at -7.32% and pulses at -0.28% helped to keep the overall WPI inflation in check in the month.
Capsule of WPI components over last 3 months

Commodity Set	Weight	Sep-22 WPI	Aug-22 WPI	Jul-22 WPI
Primary Articles	0.2262	11.73%	14.93%	14.78%
Fuel & Power	0.1315	32.61%	33.67%	44.62%
Manufactured Products	0.6423	6.34%	7.51%	8.24%
WPI Inflation	1.0000	10.70%	12.41%	14.07%
Food Basket	0.2438	9.08%	9.93%	9.28%

Data Source: Office of the Economic Advisor

In the earlier part of the year, the inflation trend was first set by higher crude prices. However, once the oil prices started tapering on recession fears, the producer inflation in food and manufactured products still remained quite high. The overall vegetables basket inflation has now come down, led by negative onion inflation. However, potato inflation continues to be harsh. On core food products, inflation in pulses is flat to negative but the inflation in cereals continues to be quite high; especially due to the weak Kharif season this year. Primary Articles inflation fell from 14.78% in July 2022 to 11.73% in September 2022.

Between July 2022 and September 2022, fuel inflation fell from 44.62% to 32.61%. This is largely due to two reasons. Firstly, recession fears have kept the crude prices under check. More importantly, the government has asked the oil marketing companies to hold the retail prices of petrol and diesel to prevent higher inflation levels. It remains to be seen if such largesse can be sustained since the government is likely to compensate the OMCs to the tune of Rs22,000 crore for oil marketing losses.

On the positive side, the manufacturing inflation has fallen consistently from 11.39% in April 2022 to 8.24% in July 2022 and further to 6.34% in September 2022. Clearly, the tightness forced by the RBI and the fears of a recession globally have led to tapering of manufacturing inflation. Global tapering of commodity prices and a slowdown in China have also helped the cause, indirectly if not directly. In the context of WPI inflation, manufacturing has a lot more importance due to its weight of 64.23% in the WPI basket. One hopes that this low inflation is not an outcome of weak demand, falling income levels and a general pessimism about economic conditions. That is not a good problem to have.

How the high frequency data looked in September 2022

While WPI inflation is generally presented YOY, the high frequency data on a MOM basis gives useful insights on the short term momentum. The high frequency data captures short term shifts much better.

·         For September 2022, overall MOM WPI inflation was down -0.65%, so the momentum is consistently tapering. June was the last month of positive MOM WPI inflation. Since July, the MOM WPI inflation has been negative at -0.90%, -0.58% and -0.65% respectively.


·         The MOM data captures the short term momentum. If you look at the sub-components of the WPI basket, only the fuel basket has a positive MOM inflation, showing that OPEC language has hardened prices in the short run. Other than oil; the MOM inflation for food products, primary products and manufactured products have all been negative.


·         Let us talk about the manufacturing part of the basket which saw -0.49% contraction in September 2022. Out of the 22 industry groups, 12 saw price rise, 8 saw price fall while 2 sectors were neutral. The reduction in manufacturing inflation in September 2022 has been mainly supported by sectors like basic metals, food products, chemicals, chemical products, textiles and non-metallic mineral products..

MOM numbers capture short term trends better but they also tend to be vulnerable to short term base effects. The message is inflationary only on the oil and gas front.

RBI must be happy that rate hikes are working

If the RBI has been disappointed by the reaction of CPI inflation, the positive impact is in WPI inflation, which has shown consistent tapering since May. However, weak WPI inflation for too long is also not a good sign as it shows weak demand that eventually reflects in tepid output growth. We have already seen that happen in the case of IIP numbers, where the growth has dipped to negative territory. That is something to be cautious about.

The RBI has been on the horns of a dilemma as to whether it should go the hawkish way like the US central bank or stick to growth revival like the Chinese central bank. The truth probably lies somewhere in between. However, the WPI data will give a lot of comfort for the RBI as it shows that rate hikes are working. WPI is normally the most sensitive to rate hikes and that is evident in falling WPI inflation. However, this needs to translate quickly into CPI inflation transmission. Otherwise, financial markets are notoriously impatient.

Look at the time series data for WPI inflation. 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 November 2022, WPI inflation fell sharply from 16.63% to 5.85%; a fall of 1,078 basis points. WP inflation is now at a 21-month low.



Data Source: Office of the Economic Advisor
The negative causal relationship between rate hikes and fall in WPI inflation appears to be working perfectly. Consider this causality. Between May 2022 and November 2022, the RBI hiked repo rates by 225 basis points from 4.00% to 6.25. During the same period, WPI inflation fell 1,078 bps from 16.63% to 5.85%. That is because rate hikes hit the manufacturing sector first but take time to trickle down to the retail level.
The Monetary Policy Committee (MPC) of the RBI should take solace from the fact that the WPI inflation has reacted sharply to the rate hikes. Clearly, with the CPI inflation being a lag indicator, it should follow suit. In May 2022, WPI inflation had touched a 31-year high of 16.63%. WPI inflation had actually become a lot steeper in 2022 due to the Ukraine war, impact of Russia sanctions, China’s zero-COVID lockdowns and global central bank hawkishness; apart from high inflation and pressure on cost of funds.
 
WPI inflation is tapering across the board
The sharp fall in WPI inflation has been literally across the board. Manufacturing inflation yoy fell from 6.12% in September 2022 to 4.42% in October and now to 3.59% in November 2022. Since manufacturing has a weightage of 64.2% in the WPI basket, it had the highest impact in pulling down the WPI inflation. Food inflation and energy inflation have also been tapering amidst a global commodity correction. While food inflation has fallen from 8.02% to 2.17% in the last 3 months, the fuel inflation has fallen from 33.11% to 17.35%.
The highest producer inflation in October 2022 was in HSD at 42.10% followed by crude oil at 33.87%, wheat 18.11%, potatoes at 13.75%, cereals 12.85%, paper products at 8.31% and mineral products at 7.10%. 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 November 2022. Vegetables at -20.08%, Onions at -19.19%, LPG at -13.40% and vegetable oils at -5.10% helped to keep the overall WPI inflation in check in November 2022.
How WPI inflation fared over the last 3 months

Commodity Set	Weight	Nov-22 WPI	Oct-22 WPI	Sep-22 WPI
Primary Articles	0.2262	5.52%	11.04%	11.54%
Fuel & Power	0.1315	17.35%	23.17%	33.11%
Manufactured Products	0.6423	3.59%	4.42%	6.12%
WPI Inflation	1.0000	5.85%	8.39%	10.55%
Food Basket	0.2438	2.17%	6.48%	8.02%

Data Source: Office of the Economic Advisor

The latest reading on WPI inflation is important for several reasons. Firstly, WPI is a much better test of the efficacy of rate hike impact since the impact is felt first on WPI inflation and CPI inflation is normally with a lag. Secondly, in early 2022, 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 is across the board with lower manufacturing inflation being driven by lower input costs as well as lower food prices, despite pressure of a weaker than expected Kharif this year. Also, among key input costs, raw material costs, power costs, transportation costs and manpower costs are also gradually normalizing.

There are 3 risks to the WPI inflation as we see it. Firstly, higher cost of funds has imposed a higher financial cost on companies. Secondly, crude market could see a lot of disruption if the EU deepens its sanctions on Russia. While currently, Russia is selling surplus crude to India and China, it would be hard to absorb the gap left by Europe. Lastly, the bet is that despite a weak Kharif Rabi should be good. A lot is reliant on this assumption.

What we gathered from the high frequency WPI data

While WPI inflation is generally presented YOY, the DIPP also presents a high frequency MOM picture. This is on the lines of what the BLS provides in the US, where equal weightage is given to YOY inflation and also to high frequency inflation. This can provide useful insights on the colour and direction of short term momentum as it captures short term shifts and macro pressures more effectively than the YOY data.

• For November 2022, overall MOM WPI inflation at -0.26%, reverted to its negative posture after a break of one month in October. 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 markets may not have budgeted for.
• Where is the MOM pressure actually coming from? For the month of November 2022, the pressure is coming from the fuel basket, which is up 2.84% on a MOM basis. That is largely on account of supply cuts by the OPEC, which has pushed up the oil prices on a MOM basis. However, Indian oil prices are still artificially fixed, so may not be reflective.
• The big boost to the fall in short term WPI inflation has come from the primary goods and the food basket. Food prices are down sharply, led by vegetables and onions. Unlike the previous few months, in November, it is the primary basket and the food basket that have actually driven the inflation levels sharply lower.

MOM numbers capture short term trends better but they also tend to be vulnerable to short term base effects. It works both ways, but is a key input to track.

Enough of missives; time for RBI to change tack

If the RBI would be pleased to see the retail CPI inflation dipping below 6%, the bigger cause for celebration is the WPI inflation falling over 10 percentage points since the May peak. WPI inflation as an example of how inflation targeting works in practice and that is what the RBI must now explain to the government. Inflation is a worry, but not a concern. The real concern is that high cost of funds is putting pressure on the interest coverage ratio of Indian companies and the rural demand is under a lot of pressure.

How can the RBI address this situation. As MPC members like Jayanth Varma and Ashima Goyal have pointed out, it is time to pause on rate hikes and focus on growth. India is pleased to talk about being the only large economy to grow at 7%, but now the RBI and the government have to their bit to boost growth. Growth needs low cost of funds and adequate liquidity, which is not possible with the anti-inflation posture adopted. It is high time, the RBI clearly shifts its focus away from inflation and towards economic growth.