Inflation at 8.98%: Unravelling the 'Jigsaw Puzzle'

The rabbit is out of the hat. Inflation (That is measured by Wholesale price Index - WPI in India) is down to 8.98% as on 1st November 2008, as compared to the figure of 10.72% declared for the week before. This is likely to have a ripple effect on the mindset of the analysts, market operators. But for the common man the inflation data still remains a jigsaw puzzle: with the price of fruits and vegetables at their peak (tomatoes at 40 Rs. a kilo or potatos at 20 Rs. a kilo in the retail market), he is unable to appreciate the fall in the inflation rate.

In this blog on 24th August 2008, when WPI was at its peak of 12.6%, I had carried an analysis of inflation under the title 'Inflation: What lies beyond the figures!'. Let us once again try to unravel the mystry behind the figures:

• In India the benchmark for measuring headline inflation is WPI (Wholesale price index), which is released every Thursday by the Department of Industrial Policy & Promotion (DIPP) under Ministry of Commerce & Industry.
• As a consumer you and me are more impacted by the CPI (Consumer Price Index), generally CPI follows WPI with a lag effect, that is retail prices start falling at a later stage as compared to wholesale prices.
• The WPI figures released every week, that haunt the headlines, must be taken with a pinch of salt. They represent the growth in inflation rate on a year to year(YOY) basis, so are influenced by the base inflation rate. In India the WPI during November 2007 was only 3.4%, so the low base effect makes the comparison look absurd.
• The composition of WPI is loaded towards manufactured articles which account for 64% of the weightage, food articles and fuel & lubricant catagories account for 22% and 14% respectively. Whereas the CPI carries a weightage of over 50% for Primary articles.
• The sharp fall in inflation figures on a week on week basis, as on 1st November 2008, is due to the sharp decline in commodity prices especially steel goods, and the sharp decline in price of unadministered petroleum goods such as Naphtha and Aviation Turbine Fuel (ATF)
• If the Govt decides to reduce the price of Petrol and Diesel marginally, as is being widely anticipated, the WPI will fall below the 8% levels soon.
• The spike in inflation in the past few months was due to international factors, namely the 'commodity bubble', which has burst leading to the sharp decline in inflation numbers. Authorities in India extended the inflation argument to the extreme and have stifled the economic growth in the bargain.
• The collection of inflation data also leaves a lot to be desired, the Govt. machinery is inept in collating the figures realistically leading to distortions. That is why the provisional figures released are revised on a regular basis.

All said and done the WPI continues to decide the policy of the Govt. of India as well as RBI. In that sense this current fall is significant: it signals a softer interest rate regime, forcing the RBI to reduce Repo/ Reverse Repo rate shortly. This will reduce the interest burden on the companies, thereby improving their profitability. But the result will be seen from the Quarter ending March 2009, the results for Quarter ending December 2008 are likely to be depressed. The markets may initially cheer the good news. The fact to be appreciated is, that the long term India story still remains good despite the forecasts of a severe slowdown, but then forecasting in these tubulent times is fraught with a lot of risk.

Remember, Merril Lynch who forecasted Indian stock market (BSE sensex) to rise to 25000, when the index was around 20000 in December 2007, Merril Lynch itself got lynched in the process. Investors should, therefore, think long term and not get bothered by the whole lot of data dished out at regular intervals, who knows the fairness of the data. The real economy is much more than just a few sets of figures!