Why wholesale and retail inflation is different

Wholesale inflation, as measured by the wholesale price index, rose to its highest level since 1991, reaching 14.2% in November. In contrast, retail inflation, as measured by the consumer price index, is at a more acceptable level of 4.9%.

Not only do the two indices show very different levels of inflation, but also their directions. While WPI inflation has risen sharply since the middle of this year, retail inflation has moved in a range.

What does this explain?

Such divergence is often attributed to the composition of these indices. Both have different components and different weights ascribed to them.

The CPI basket reflects the purchasing behavior of consumers. Consumption patterns were determined from the 2011-12 Consumer Spending Survey and, on this basis, weights are assigned to different items according to a CPI manual published by the Ministry of Statistics.

For WPI, weights are assigned based on the share of each item in total wholesale transactions in the economy according to the WPI methodology published by the Department of Commerce.

The biggest difference is in the food category.

While food makes up almost half of the CPI basket, it makes up a quarter of the WPI basket. There are also large differences in weight within the food category.

In the VPI basket, for example, grain has the highest weight at 9.7% of the total basket. According to the Ministry of Statistics and Program Implementation, milk and vegetables are the second and third largest components at 6.6% and 6%, respectively. In comparison, milk has the maximum weight in the WPI basket at 4.4%, followed by cereals and vegetables at 2.8% and 1.9%, respectively, according to the Ministry of Trade and Industry.

Another difference between CPI and WPI is services.

The “miscellaneous” category in the CPI, which makes up around a quarter of the index, includes services such as education, health, recreation and goods such as gold jewelry. These are not included in WPI.

WPI in turn includes raw materials such as minerals that are not included in CPI. Almost 60% of the WPI consists of either non-food products or raw materials.

There are also differences in the composition of the indices.

Price collections for CPI are conducted by local outlets. The data is collected from 1,114 urban markets and 1,181 villages. The selection is based on the identification of popular markets and stores. The data for WPI is obtained once a month from a survey of various entities in the private and public sectors that manufacture these goods. Price offers are collected through online surveys.

The construction of the indices explains the divergence in retail and wholesale inflation only so far. There are often other reasons for a large divergence between CPI and WPI that has also occurred in the past.

There have been divergences between the WPI and the CPI, but this level of divergence is unusual, said Pronab Sen, India’s former chief statistician.

The CPI contains finished goods, while the WPI contains primary and intermediate products. Here’s the big difference, Sen said. Production has caught up with pre-pandemic levels, but consumption is still below that level.

Food and fuel are the two components where the divergence is most pronounced.

The vegetable and fuel sub-indices in the WPI rose significantly over a period of six months, with a sharp increase in November. Retail prices in these categories also rose, but not as much.

The divergence in wholesale and retail prices for vegetables has puzzled economists. Typically these move together, said economist Abhijit Sen.

Explaining the divergence in fuel, Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership, said international crude oil prices rose in October and the rise came with a delay in the WPI. The CPI, on the other hand, reflects a decrease in excise duties, which lowered retail fuel prices.

Upadhyay said the divergence isn’t that acute when you look at the core WPI and core CPI. The core inflation indices cancel out volatile elements like food and fuels. This suggests that the rise in the headline WPI is largely led by food, mostly vegetables, and fuels. This explains in part the large gap between the two indexes, Upadhyay said.

Additionally, the divergence between the core metrics is even less when you look at the core goods CPI, which is far higher than the core CPI, Upadhyay said.

The divergence between wholesale and retail inflation affects policy decisions. Monetary policy has so far remained accommodative as retail inflation was within the central bank’s target of 4 (+/- 2%). CPI inflation is the nominal anchor of monetary policy in India.

However, if WPI inflation is to finally feed into CPI inflation, monetary policy may need to be tightened.

Vivek Kumar, an economist at QuantEco Research, said some level of pass-through from the WPI to the CPI was inevitable. The ongoing core inflation of the WPI at a record level reflects the pressure from input prices. Adjusted for the difference in index construction, this would continue to put upward pressure on core CPI inflation, said Kumar.

Historically, however, the correlation between the two indices is far from perfect, he warned. This makes it difficult to determine how much pass-through there will be this time.

Sen shares a similar view.

WPI is considered the leading index and the CPI should follow the WPI, Sen said. “Whether or not it converges depends on what happens to demand and whether it picks up,” Sen said. “If it does, then you can producers pass the price increase on to consumers. “