RBI has, for long, articulated the inflation goal in terms of the WPI but has always considered the CPI along with other variables under its ‘multiple indicators’ approach. The current debate is whether the inflation target ought to be enumerated in terms of wholesale or consumer price inflation. There are sound arguments favouring a retail price inflation target, the most significant being it represents actual living costs faced by consumers. A country-specific context must inform theoretical principles though. Here, statistical issues as well as the level of inflation divergence between the WPI and the new CPI suggest caution in shifting to the CPI as inflation anchor.
The composite CPI is less than three years old; its reliability, statistical robustness is yet to be established; and its relationship with key macroeconomic variables central to the monetary policy decision-making process is not yet known or understood. For example, rigid persistence of core-CPI inflation in 8.2-8.6% range contrasts perplexingly with contractionary indications on the real side as well the downtrending WPI inflation. The magnitude and lag of wholesale-to-retail prices pass-through is critical here and answers to which can hardly be found from 22 retail inflation data points.
By construction too, three-fifths of the index is weighted with food and fuel prices that not only tend to be very volatile, but whose role in conduct of monetary policy is debatable. Another 9.77% weight is for house rents that are largely imputed, raising measurement concerns. Eliminating these along with food and fuel prices where supply shocks dominate significantly narrows the price information embedded in the core-CPI inflation. It is also geographically sensitive, whereas monetary policy decisions are aggregate. So, an early adoption of CPI could raise the probability of policy errors induced by erratic data points in an evolving, short time series.
The second issue relates to the wide WPI-CPI divergence, close to 4-5 percentage points. RBI hasn’t really stated its official position on this or how it proposes to handle this issue even while informally inching ever-closer to the CPI. In the context of high food-price inflation persistence and the central bank’s belief that this gets generalised if left unaddressed, identification of the spillover process is very important as explained above. A formal shift could entail an upward shift in the yield curve and an across-the-board increase in the general level of interest rates in the economy. This could potentially hurt growth.
Then there is the argument that