The wholesale price index (WPI) or producer inflation had surged to a high of 16.63% in the month of May 2022. Incidentally, that was also the month when the rate hikes started in India. As the RBI hiked rates by 225 basis points between May and December 2022, the WPI inflation fell from 16.63% to 4.95%; a fall of 1,168 basis points. WPI inflation is now at a 22-month low of 4.95% and a full 65 basis points below the Bloomberg consensus estimates.

What explains this sharp negative causal effect in the case of WPI inflation but not so much in the case of CPI inflation? WPI inflation is the more sensitive inflation and hence the impact of any hike in the rate of interest is first visible in the WPI inflation. However, there is a lag for the effect to get transmitted to CPI inflation and that is the reason for the delay. More often than not, the CPI inflation is a lag indicator of the WPI inflation and that is how it is likely to play out.

Would the Monetary Policy Committee (MPC) of the RBI really be happy with the sharp fall in the WPI inflation. The assumption is that CPI inflation would follow suit, but these are early days and a lot would depend on the price of crude oil. MPC would take the falling WPI as an indication that manufacturing costs are coming down.

WPI inflation is experiencing all-round fall

The sharp fall in WPI inflation has been across the board. Manufacturing inflation yoy fell from 4.42% in October to 3.59% in November 2022 and now to 3.37% in December 2022. Since manufacturing has a weightage of 64.2% in the WPI basket, it has an oversized impact in pulling down WPI inflation. Food inflation and energy inflation have also been tapering amidst a global commodity correction. While food inflation has fallen from 6.60% to 0.65% in the last 3 months, the fuel inflation has fallen from 25.40% to 18.09%.

In terms of specific products, highest producer inflation in December 2022 was in crude oil at 39.71% followed by HSD at 35.49%, Potatoes 22.38%, wheat 20.72%, cereals 14.0%, cement 8.26% and mineral products at 7.67%. Ironically, the sharpest fall has been in manufactured products while oil inflation is up over last month. Also, in the food basket, it is only vegetables and onions that are deep in the negative, but most of the other products in the food basket are having positive inflation. For instance, vegetables at -35.97%, Onions at -25.97%, LPG at -14.76% and vegetable oils at -6.05% kept overall WPI inflation in check. 

WPI story over last 3 months

Data Source: Office of the Economic Advisor

WPI is a better test of the efficacy of rate hike impact since it is first felt on WPI inflation and CPI inflation is a lag effect. The sharp fall in manufacturing inflation is good news since it is indicative that the cost of manufacturing is going to come down across products. Also, the sharp fall in food inflation; both in the primary segment and the processed foods segment is a signal that the food cycle is finally turning favourable and could have positive impact on consumer inflation with a lag. Of course, the pressure of a weak Kharif in this year is only going to be partially offset by the positive vibes coming from the Rabi season.

One key risk to WPI inflation is that higher cost of funds has imposed a higher financial cost on companies. This could impact cost of funding for Indian companies as also have an impact on solvency. That is something to be observed.

A quick look at high frequency WPI data

While WPI inflation is generally presented YOY, the DIPP also presents a high frequency MOM picture; like the Bureau of Labour Statistics (BLS) in the US provides. High frequency data provides useful insights on the colour and direction of short term momentum and short term shifts as it captures the macro pressures more effectively than YOY data.

• For December 2022, overall MOM WPI inflation contracted by -1.12%, deeper than the cuts seen in the month of November. 
  
   
• Is there any MOM pressure likely now? For the month of December 2022, the sequential WPI inflation is lower across all categories. There are two risks here. Firstly, China has shown slower growth and a slew of fiscal boosters could prop up oil prices. Secondly, unless China joins the global supply chain mainstream, the pressure of input prices is going to be around.
  
   
• 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, although prices of potatoes, wheat and cereals are under pressure. However, overall food and primary inflation has tapered on a sequential basis.

MOM numbers capture short term trends better but they also tend to be vulnerable to short term base effects. However, it is a good measure to check the momentum of data.

RBI will shift stance, but it will shift gradually

RBI has now seen retail CPI inflation below the 6% mark for 2 months in succession. However, the bigger cause for celebration is that the WPI inflation has fallen by 1,178 basis points since the May 2022 peak. 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. For now, the focus of the RBI would be on having clarity that there is no arbitrage for risk-off investors in the US markets over India. That could trigger outflows, which can be a tight scenario.

How can the RBI address this situation. There are members in the MPC like Jayanth Varma and Ashima Goyal who have openly called for a pause on rate hikes and a shift in focus to growth. For the Indian economy, there are several imperatives as captured below.

• Firstly, the RBI and the government must do the best they can to ensure that the revival in IIP growth is sustained. One of the pre requisites for this revival is low cost of funds. That is something that RBI can control and it is essential.
  
   
• At the other end, there is the risk that too much focus on growth can take the focus away from inflation and the CPI inflation is still well above the median rate of 4% and just about lower than the maximum permissible rate. In these circumstances, the RBI may prefer to continue to be hawkish for some more time.
  
   
• The key issue may be core inflation, which continue to be sticky. The hope is that more hawkishness can bring down inflation expectations and the core inflation along with that. RBI cannot do a total shift to growth focus. It has to still focus on that delicate middle path.