Explaining This Fiscal’s Wholesale Price Deflation And What Might Be In Store For FY24-25

Normally, the word “inflation” conjures a recall, amongst analysts and economists, of the CPI-based inflation, and amongst end-use consumers, of the salient, recent changes in the cost of living, which is again represented by CPI-based inflation. 

Not as well known outside the core segment of analysts is inflation measured by the WPI, which is as important as the CPI. Policy makers and discerning analysts obsess as much about WPI as with CPI. The Reserve Bank of India has done extensive research on the channels of transmission from wholesale to retail inflation and the correlations between the two.

Decoding Real Vs Nominal GDP Gap

Step back, and recall the discussion on the recently-released GDP growth estimates for FY23-24, which turned out to be surprisingly higher than most forecasts. One of the main reasons for the higher-than-expected number was the reduction in the gap between the nominal and the real (or inflation-adjusted) growth rates. 

The nominal GDP growth for FY23-24 is estimated at 9.1 per cent compared to 14.2 per cent in 2022-23, while real GDP growth is forecast to be 7.3 per cent compared to 7.2 per cent last year. In other words, the gap between nominal and real GDP growth rates has shrunk to 1.8 percentage points this year from 7 percentage points a year ago. 

The key reason for this is the unusually low WPI inflation in the current financial year, driven by a deflation in prices of manufactured goods. 

The GDP growth estimates are, for a large part of manufacturing and services, nominally derived from the published financial results of listed companies for those segments. These are then adjusted for inflation, using a combination of WPI- and CPI-based inflation (known as deflators in GDP estimation), to arrive at the real GDP growth numbers. 

For the total GDP basket, the deflator roughly comprises of 40 per cent WPI and 30 per cent CPI-based inflation. The remaining 30 per cent is estimated from volume based data (like food grain output, rail and road freight, electricity generated, etc,) and then translated up into value terms using appropriate price indexes. 

The Negative WPI Inflation Story

This brings us back to wholesale price inflation, which is akin to B2B (that is changes in bulk pricing), whereas CPI inflation is more like B2C (that is changes in retail pricing). 

Why has WPI-based inflation turned negative in FY23-24, which is about to end, and how might this change next year, that is FY24-25? 

Manufactured goods account for nearly two-thirds (64 per cent) of the wholesale price index, which is why the movements in the prices of the former directionally influence the latter. 

For a fairly long period of time since the new WPI series was introduced in 2011-12, the headline wholesale price inflation had remained muted, averaging below 2 per cent between FY12-13 to FY19-20, the only exception being FY18-19 when it had risen to 3.7 per cent. 

With the outbreak of the Covid-19 pandemic, which caused widespread supply chain disruptions and forced central banks to pump more money into the system by economic stimulus packages, the WPI manufacturing inflation rate began to rise steadily – from 1.4 per cent in August, 2020 to a peak of 12.9 per cent in October 2021. 

The initial months after the start of the Russia-Ukraine war made it worse, leaving FY21-22 with an average WPI manufacturing inflation of 11.1 per cent. Fuel and energy inflation had also soared immediately post the conflict, and had remained high for most of FY22-23.

Making things worse, even food inflation had soared, particularly cereals, due to a global shortage of wheat and edible oils due to export blocks from Ukraine and the effects of El Nino in southeast Asia. 

However, once the world came out of the pandemic’s shadow and the initial shock of the Ukraine war waned, manufacturing prices began to soften. Aided by the effect of a high base in FY21-22 continuing into the first half of FY23, WPI inflation (both headline and manufacturing) in FY23-24 has remained muted, due to deflation in both manufactured and fuel prices, but offset to some extent by continuing high food inflation. 

As mentioned earlier, the focus in this article is on manufacturing inflation, since this segment is of most interest in deciphering inflation adjusted growth signals. Within the WPI basket, the major components of manufacturing goods comprise metals (9.7 per cent), food products (9.1 per cent), chemicals (6.5 per cent) and textiles (4.9 per cent).

Basic metals prices fell 5.2 per cent year on year during the April-February period, food products by 3.3 per cent, chemicals 6.0 per cent and textiles another 6.0 per cent. (See Chart) 

The reasons are not hard to decipher. On non-food and textiles segments, the proximate cause was China’s subdued growth and demand. When China opened up, abandoning its zero COVID policy toward the end of 2022, analysts expected a surge in demand, lifting both commodities and services prices. 

China is a dominant commodities user and importer. When China’s growth underwhelmed relative to expectations, global industrial commodities and crude oil prices dropped. Steel, metals, chemicals prices have remained depressed due to weak demand from China. Some of the softer petroleum products prices fed through into raw materials for textiles as well. 

Also, global trade growth sharply decelerated in 2023, with the IMF reporting that volume growth had slowed to 0.4 per cent year on year, down from 5.4 per cent in 2022. Weak to moderate European growth has added to this softness. The large EU economies, notably Germany, have been struggling. Germany’s difficulties are partly tied its trade linkages with China, whose economy has slowed. 

But this weakness in commodity prices was offset by sticky and high inflation in services. Whatever the growth recovery, this was largely led by services, mostly tourism, travel and hospitality demand, a result of a backlash against the lockdown restrictions. This had prevented central banks across the world from walking back from the aggressive and sustained rate hikes of 2023. 

Outlook For FY24-25

Going forward, WPI-based inflation is widely expected to normalise through 2024-25. Commodity prices may inch upward with improvement in China’s economic recovery. The IMF forecasts that global growth will remain at about 2023 levels, around 3.1 per cent, although there is a chance that growth will accelerate in 2024. 

Higher government spending in some economies, monetary policy easing and improving customer demand due to falling inflation and greater affordability may yield a better number for the global economy in the coming year.

From a moderate deflation of 0.6 per cent to 0.8 per cent in headline wholesale prices in the current fiscal, FY24-25 will likely see an inflation rate averaging between 1.2 per cent to 1.5 per cent, maybe somewhat higher.

What does this imply for monetary policy? If wholesale prices rise, given the underlying resilience of demand and growth, this might translate into a somewhat higher core consumer price inflation, raising headline CPI inflation to a bit above RBI’s FY25 forecast of 4.5 per cent. That may guide the central bank to keep key interest rates unchanged for longer than industry and investors would wish to. 

(The writer is former Chief Economist, Axis Bank. Views expressed are personal. Abhijit Mukhopadhyay at The Secretariat also contributed to the article)