While the RBI has moved to CPI, FinMin remains on WPI..

Finance Minister in  his 2014-15 interim budget speech says:

Last year, when I read the Budget speech, WPI headline inflation stood at 7.3 percent and core inflation at 4.2 percent. Through the year, inflation saw its ups and downs. At the end of January 2014, WPI inflation was 5.05 percent and core inflation 3.0 percent. Both the Government and the RBI have acted in tandem. While our efforts have not been in vain, there is still some distance to go. Food inflation is still the main worry, although it has declined sharply from a high of 13.6 percent to 6.2 percent.

One may question whether RBI and FinMin have acted in tandem to tame inflation as latter was more into growth issues. But the differences over which index to use – WPI or CPI-  remains.  And this is not the usual FinMin RBI fight (as they have stopped for the wrong reasons) but has much deeper ramifications.

WPI has been the main indicator for measuring price inflation in India. Apart from using WPI to measure inflation, it is also used to calculate nominal GDP which is then used to calculated all ratios like Fiscal deficit, CAD etc as % of GDP. Then there are all kinds of contracts which are based on WPI for pricing etc. Even in CPI, if one is in rural area should the contract be in  CPI-rural terms or CPI-composite? With WPI there was no such problem.

The recent Budget throws this problem. In estimating the fiscal deficit target as % of GDP, the statement says:

GDP for BE 2014-2015 has been projected at Rs 1,28,39,952 crore assuming 13.4% growth over the Advance Estimates of 2013-2014 (Rs 1,13,20,463 crore) released by CSO.

The document does not mention CPI but it is likely to be on WPI as even budget speech does not mention CPI at all. CSO has still not given its estimate for next year, it is likely to be 6.2% growth rate and 6.2% inflation based on WPI ((1.062*1.062)-1) = 13.4% NGDP growth rate). CPI estimates could be higher at around 8% or so based on RBI’s recent guidance. It could be higher/lower as well given how volatile food prices have been which form majority of the CPI index.

On this front, govt. is actually showing some prudence. By jumping to CPI, it can easily inflate the debts away. Using CPI would likely lead to a much higher NGDP and much lower fiscal deficits as % of GDP. This might just improve the market sentiment big time. Imagine the FinMin announcing the fiscal deficit for 2013-14 is at 4% and next year projected at 3.5% using CPI for NGDP. Markets will be confused and look for errors only to realise that govt has  shifted to CPI. But would that mean fiscal deficits have been cut drastically? Not really..

So hey governments are not always irresponsible as we deem them to be.

So, it is not as if RBI can shift to CPI randomly. There are a whole lot of things which have been connected to WPI and there is a historical legacy. The central bank cannot wake up one day and say we are going to target CPI leaving it for whole system to figure ways to compute/adjust. There has to be a more systematic and coordinated approach to move to CPI.

This random shift by RBI without any systematic approach becomes a serious problem. The institutions will use different measures of infation for calculation. Even RBI which releases CAD data computes it based on NGDP given by CSO. So even RBI faces this conflict – it targets CPI but uses WPI to calculate and project these numbers.

The analysts have their own source of problems.  Now for inflation forecasting and figuring RBI policy one would look at CPI. But for other activities he will have to look at the RBI discarded WPI. till the differences between CPI and WPI do not narrow, things will remain like this.

RBI top brass needs to be more patient with its recent proposed changes. There is too much hurry and impatience being shown without any broadbase thinking and debating.  Ideally, Government and RBI should coordinate/debate and act on these changes.  But as govt is on vote of account/election mode RBI is just using this space to press changes in a highly adhoc manner. This is least expected from an institution like RBI. Changing things as it pleases them without any real thinking and accountability.

Patience is central to economic changes and RBI is the best example of this approach. Someone may propose a change, others may debate it and completely different people  end up implementing it. However, the current RBI regime wants to do all these together in very quick time. Big bang seems to be in fashion when it has failed most of the time. It might excite markets but it remains short-lived.

Government still remains in charge and should act on this issue.. As said this is not a RBI/FinMin fight as explained above..

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