WPI Turning Positive In Coming Months Pose Risk To RBI's Target Of Durable CPI At 4%

India’s WPI inflation rate, which has remained in the deflationary zone for six consecutive months this year, is soon to turn inflationary in the coming data prints due to fading support of a high base effect and lower contraction in prices of fuel and power, and manufactured products. The turnaround poses risk to the Reserve Bank of India’s target of bringing CPI inflation to 4 per cent on a durable basis.

In September, wholesale inflation rose to -0.26 per cent from -0.52 per cent in August. Economists are of view that WPI will gradually turn positive in the second half of current fiscal with continued rise in prices of certain key food items.

 “Barring vegetables, prices of most other food items rose sequentially, particularly cereals, pulses, eggs and meat, spices, and even fruit. This indicates price pressure in food persist, despite some cooling of the seasonal price surge,” Economists at Barclays said in a report.

Though food inflation saw a decline to 3.35 per cent in September from 10.6 per cent in August on account of a sharp contraction in the prices of vegetables, the prices of cereals, pulses, wheat, onions, and milk accelerated during the month.

Typically, a rise in wholesale prices of food items has a lesser pass through to CPI inflation than those of items in the Core section. However, a sustained pressure on prices of these key food items can filter into the retail level with a lag.

 “The key risk to CPI remains from food inflation, as the index gives 46 per cent weight. The impact of uneven monsoon on crop output will need to be monitored as reservoir levels are lower than last year and last 10-yr average,” said Gaura Sen Gupta, Economist, IDFC First Bank.

While WPI inflation shows the change in average prices of commodities on the wholesale side, CPI inflation reflects the change in prices on the retail front.

Diminishing Support

Considering this possible pass through, RBI’s ambitious target to keep inflation not just within the tolerance band of 2-6 per cent, but to bring it to 4% on a durable basis, faces risk in the long-run despite softening of vegetable prices.

“I would like to emphatically reiterate that our inflation target is 4 per cent and not 2-6 per cent,” said RBI Governor Shaktikanta Das in a press conference post his policy review announcement on October 6.

India’s retail annual inflation moderated to 5.02 per cent in September from 6.83 per cent in August, primarily due to a sequential crash in prices of vegetables, particularly tomato, and LPG.

Also Read | With Softening Food Prices, Economists Expect RBI To Prioritise Growth Over Inflation

However, RBI in its words aims for durable inflation, which makes the WPI inflation trajectory crucial for the central bank.

Apart from food, another concern emerges from the diminishing support of Core WPI inflation, which has contributed in bringing down Core CPI inflation with the lagged effect of its deflationary trend that started before the current fiscal. Core WPI inflation was seen at -1.3 per cent in September compared with -2.1 per cent in August.

As a result of the delayed effect, Core CPI inflation moderated to the lowest in current fiscal of 4.5 per cent in September from 4.9 per cent in August.

“There is a strong correlation between Core CPI inflation and Core WPI inflation at 75 per cent,” said Sen Gupta. She expects Core WPI inflation to remain at 0.9 per cent on year in the second half of 2023-24, compared with -2.0 per cent in the first half.

Key Drivers

The increase in prices of fuel and power remains a key driver in bringing WPI inflation closer to the positive territory, with the possibility of rising crude oil prices to add further upward pressure. Economists expect Indian crude basket to average around $90 per barrel in the second half of current fiscal.

The contraction in fuel and power prices was seen at -3.35 per cent in September compared with -6.03 per cent in August.

Besides fuel and power, lower contraction was also observed in manufactured products with a decline to -1.34 per cent in September from -2.37 per cent in August.

“Easing momentum in core inflation and declines in vegetable prices are driving the moderation in retail inflation. But the sequential rise in the WPI for manufactured products bears watching, if producers pass on higher costs into retail prices,” the report by Barclays said.