Divergence between CPI and WPI

Divergence between CPI and WPI

Subject: economy

Section: Inflation

Context:

One striking feature of the Indian scenario is the difference between inflation as measured by the WPI and that evident in the Consumer Price Index (CPI)

WPI inflation during the current financial year, in contrast to the trends observed in CPI-C inflation, has shown an increasing trend, and remained high. Between June 2019 and February 2021, wholesale inflation was lower than retail inflation, while between March 2021 and December 2021, wholesale inflation remained above the retail inflation.

While on the one hand, low food inflation pulled down CPI, on the other hand high energy and input prices pulled up WPI based inflation rate

The annual increase in the WPI was more than 13 per cent; the CPI increased at less than half that rate

Divergence between CPI and WPI

Cause of divergence between CPI and WPI

• Base Effect:
• A part of the high inflation in WPI being witnessed currently could be because of a low base in the previous year. Consequent to the impact of the COVID-19 pandemic, production activity remained muted in 2020-21 and global crude oil prices reached record lows due to lack of demand. Therefore, the WPI based inflation rate touched a low of 1.3 per cent in 2020-21. With economic activity picking up in 2021-22 and edging up of global crude oil prices, the low base of 2020-21 led to WPI inflation reaching a peak of 14.2 per cent in November 2021 and 12.5 per cent during April-December 2021 (as against 0.04 per cent during April-December 2020-21).
• Difference in the weight of various items
  • To begin with, the WPI excludes services altogether, covering only produced goods.
  • Within goods, the CPI gives a much higher weight to food articles, which account for nearly 46 per cent of the basket, compared to only 15 per cent in the WPI. (In fact, the CPI for rural areas gives as much as 54 per cent weightage to food and beverages, while in urban areas it is 36 per cent.)
  • Weights of items in CPI-C are based on the consumption pattern of consumers and households, in case of WPI series, weights of the item basket are derived by calculating the net traded value to the domestic production by adding net imports to domestic production
  • While in CPI, food and beverages have the highest weight (45.9), in WPI, the manufactured group has the highest weight (64.2)-food inflation witnessed a decline in 2021 and was 4.0 per cent in December 2021, food articles have a weight of only 24.4 in the WPI (Food articles in primary group plus those in manufactured group). WPI is thus less responsive to changes in food inflation.
  • The weight of the fuel group is much lower in CPI (6.8) as compared to WPI (13.2). Fuel in CPI is also partially reflected under miscellaneous group under ‘transport and communication’-with reopening up of the economies worldwide, unanticipated increase in energy prices and emergence of industrial input cost pressure and high freight costs led to a sharp spike in WPI inflation in 2021.
  • In November 2021, a reduction in central excise duty was announced for diesel and petrol. While this cut in central excise duties and subsequent reduction in VAT by majority of the states had a dampening effect on retail prices of diesel and petrol, wholesale prices continued to reign high resulting in the widening of the divergence
  • The CPI basket consists of services like housing, education, medical care, recreation etc. which are not part of WPI basket.
  • The manufactured sector not only uses crude oil but also several other imported items as inputs such as iron ore, aluminum, other metals and cotton. The intermediate and inputs items of WPI, not part of CPI, play a role in its divergence from CPI.(Domestic inflation as measured through WPI of related items have been highly correlated with growth in the international prices of these commodities. The inflation in domestic aluminum and copper prices is positively and highly correlated with international prices).
  • India is a major producer, consumer, and exporter of cotton. Therefore, the prices of domestic cotton and international prices are closely linked leading to a high correlation (0.9) between WPI inflation in cotton yarn and international inflation in raw cotton.
  • Similarly, the movement in prices of non-tradable items included in the CPI basket widens the gap between WPI and CPI movements. The relative price trends of tradable vis a vis non-tradable is an important explanatory factor for divergence in the two indices in the short term.
  • The high inflation rate reported in the manufactured Group in the WPI is therefore significantly attributable to “imported inflation” resulting from high prices of imported inputs. High freight costs and longer delivery times further exacerbated the price pressure on imported inputs.

• Low Demand: Another reason for divergence is the lagging demand pick up. While production has gradually picked up in 2021-22 to reach the pre-pandemic levels, consumption demand is yet to normalise fully.