Markets more efficient as WPI, CPI converge
The inflation indices, Wholesale Price Index (WPI) and Consumer Price Index (CPI), which had been diverging since 2008, now appear to be converging. The reducing gap between CPI and WPI is a sign of an efficient market.Updated: Dec 19, 2016 18:13 IST
The inflation indices, Wholesale Price Index (WPI) and Consumer Price Index (CPI), which had been diverging since 2008, now appear to be converging. The reducing gap between CPI and WPI is a sign of an efficient market.
WPI grew at 3.15% and CPI 3.63% in November, leaving a negligible 0.48 percentage point gap between the two indices.
WPI inflation reflects changes in producer prices, while CPI, also known as retail inflation, measures variations in prices of a basket of consumer goods and services.
According to a Religare research note, “In an efficient market, the price changes at the producer level will immediately translate into price changes at the consumer level. This ensures that the gap between WPI and CPI does not remain wide for too long and will tend to converge towards a more reasonable gap of 1-3%.”
In FY16, the CPI was hovering at 5-5.5% range, while WPI was negative throughout the fiscal. The gap between the two inflation indicators was at its peak in September 2015 at 9 percentage points.
The two indices are also different as the base years are not the same. WPI is calculated with base year for prices as 2004-05, while CPI changed its base year to 2011-12 in January 2015. But the difference in base year cannot be the reason behind the convergence as the gap between the two kept increasing even after the CPI base year was changed.
“The convergence is largely due to the difference in the composition of these indices and the weights assigned to the various sub-indices. The CPI has a higher weight for the food category (46%) and food prices have been declining in recent months,” says Kavita Chacko, economist, CARE Ratings.
“Food prices have been declining due to a good harvest on account of a good monsoon. More broadly, the data also shows that the price impulses from the wholesale markets have been carried over to the retail markets almost immediately, leading to the convergence,” said Rishi Shah, economist, Deloitte India.
On the other hand, the WPI has a lower weight for food products. Prices of non-food items like fuel & power and manufactured products account for nearly 80% of the WPI index. A chunk of the WPI index is directly affected by movement in international commodity prices.
“Global commodity prices have recovered somewhat over the past two months imparting some upward momentum to the WPI index,” adds Shah.