A New Headache As WPI-CPI Gap Narrows

For micro, small, and medium Enterprises (MSMEs), the rising prices will be a double whammy, as they will witness rising input costs and a higher interest burden on the one hand and a slowdown in consumer demand on the other. 

The worst hit, however, will be consumers, especially the poor, who will have to pay more for basic necessities like food and fuel. For them, inflation is nothing but hidden taxation.

Narrowing Gap 

The Wholesale Price Index (WPI) inflation jumped to 11.39% in September, up from 9.92% in August, driven mainly by manufactured products, food, and fuel. Core wholesale inflation, which excludes food and fuel prices, also accelerated to 9.69%, indicating that cost pressures are broad-based rather than confined to the volatile prices of kitchen items.

Closely following WPI, retail inflation, measured by change in the Consumer Price Index (CPI), rose to 5.54% in September, well above the Reserve Bank’s 4% medium-term target.

The WPI-CPI spread narrowed from 5.95 percentage points in May to 5.1 points by August, with the convergence driven mainly by rising retail prices rather than falling wholesale prices.

This pattern matters because wholesale inflation typically leads retail inflation. 

Manufacturers and traders first absorb higher raw material, fuel, and logistics costs, and when margins become unsustainable, they raise consumer prices. Current data suggest this producer-to-consumer pass-through is underway and may run further, hitting consumers harder.

“Elevated commodity prices are concerning as they could sustain wholesale price pressures and indirectly feed into the CPI basket,” opined Rajani Sinha, Chief Economist, CareEdge Ratings.

Expressing a similar opinion, Sonal Badhan, Economist, Bank of Baroda, said, “core WPI—excluding food and fuel — rose to 9.8% in September from 8.1% in August, its highest under the new series, indicating that underlying producer-price pressure is broad-based.”

MSMEs Bear Brunt

MSMEs are particularly vulnerable to this inflation cycle because they operate on thin margins, limited pricing power and constrained working capital, said an expert, adding, “larger enterprises with deep pockets can negotiate favourable terms with suppliers, hold inventories and even absorb temporary cost increases as compared to their smaller counterparts.”

For MSMEs, the immediate impact of price rise is on margins. For instance, MSMEs producing garments, food products, auto components, or construction material face costlier fabric, packaging, metals, fuel and freight. Above all, they always run the risk of losing price-sensitive customers as and when they decide to raise the price of their products. 

Also, the decision of the Reserve Bank to hike the interest rate aggravates financial problems for MSMEs as several of their loans are linked to external benchmarks, including the repo rate. Earlier this month, the RBI, after a gap of nearly four years, raised the benchmark repo rate by 25 basis points to 5.5%.

The RBI rate increase transmits quickly into higher interest outgo. With the repo rate at 5.5%, the MSMEs with limited cash buffers face higher interest burden, costlier overdrafts and reduced access to fresh credit.

The RBI’s Dilemma

The RBI primarily targets CPI inflation, but persistent wholesale-price pressure complicates policy because it signals future retail inflation. If core inflation remains elevated and the CPI-WPI gap continues to narrow, the central bank may judge that demand and expectations need firmer restraint.

RBI Governor Sanjay Malhotra, while unveiling the bi-monthly monetary policy, said, “The MPC (Monetary Policy Committee) … decided to change the (policy) stance to calibrated tightening”, thus indicating that there could be more rate hikes in the coming months.

Markets also see a further rate increase as possible, with some analysts even flagging the risk of an unscheduled move if inflation and rupee pressures intensify before the December policy review. A hike would help anchor inflation expectations but would also raise loan and deposit rates across the economy.

The Policy Trade-Off

For the government and RBI, the challenge is to curb inflation without choking MSME credit. Policy initiatives to ensure timely payment clearance, subsidised credit, and better logistics can help smaller firms at this point of time.

However, if retail inflation continues to catch up with wholesale inflation, the RBI’s choice becomes harder. It has to either tolerate persistent price pressure or raise rates and risk slowing an already fragile MSME sector.