Reserve Bank of India (RBI) governor Duvvuri Subbarao today admitted that there was some merit in the criticism levelled against the central bank for excessively analysing inflation data based on the wholesale price index (WPI) while formulating its monetary policy.
Critics of the central bank’s policymakers have said that the WPI does not capture the final prices that consumers actually experience in the market. Subbarao admitted that the consumer price index (CPI) — at least in theory — was a better indicator of what was happening on the demand front.
This is because any sustained increase in wholesale prices may lead to either an increase in prices by retailers or a squeeze in their margins if the hike is not passed on. If the demand is strong, retailers may pass on the increase in wholesale prices to consumers.
But if the demand is weak, they will be forced to partly absorb the increase in wholesale prices.
An accurate indication of demand pressures is crucial for the RBI in the context of monetary policy as any action it takes impacts demand.
Delivering the inaugural address at the Statistics Day Conference of the RBI, Subbarao said the RBI should be “guided more by the CPI which more accurately reflects demand pressures because it is demand pressures that monetary policy action can influence’’.
He, however, said CPI data was also flawed and it wasn’t updated regularly to serve as a true indicator of inflation data in the economy. There were other problems as well.
India does not have a single CPI that is representative of the whole country. At present, there are three CPIs, which represent different segments of the population.
“Last year, the WPI series was revised to the base of 2004-05 whereas the existing CPIs continue with the old base … which makes CPIs ill-equipped to capture the price behaviour caused by the rapid structural changes in the economy,’’ Subbarao said.
Ruefully admitting that the central bank’s inflation forecasts had gone haywire in the past, the RBI governor recalled what comedian Groucho Marx once said: “Never make a forecast, especially about the future.”
Subbarao said unlike Groucho, the RBI unfortunately did not enjoy the “freedom of choice in this regard’’.
Subbarao added that as a matter of policy guidance for stakeholders, the RBI was obliged to give its projection of inflation. “Such a projection is evidently based on data available at that point in time. But if the provisional data that we feed into the econometric model is off-track and does not exhibit any systematic pattern, our projections of inflation too gets off-track,’’ he said.
The RBI has forecast that inflation will moderate to 6.5 per cent by the end of March next year.
There is a time lag associated with inflation data and the RBI governor said the lags and relentless revisions were making the task of monetary policy formulation very hard for the apex bank.
“In the context of monetary policy formulation, it is important to have a robust primary measure of inflation at the national level,’’ he said.
According to the RBI governor, while the central bank makes policies in real time, if the provisional data that they are based on are inaccurate, the resultant policy actions can turn out to be sub-optimal choices.
, while commending the Central Statistical Office for the “compilation and dissemination of CPI (Urban), CPI (Rural) and the CPI for the country’’
Inflation targeting has become an obsession with the RBI since September 2008 when Subbarao took over as the governor. The RBI has raised its key short-term rate by 250 basis points since March last year. Last month, it signalled that the repo would be its sole rate-signalling instrument. The repo rules at 7.5 per cent.
The RBI has been fighting a losing battle to quell inflation, which now threatens to surge into double digits after the snowballing effect of the recent increases in diesel, cooking gas and kerosene prices courses through the economy. Data presented in early June estimated inflation in the month of April at 9.03 per cent.
But even this data suffered from infirmities. “Long time series data, especially for the back period are not available for these new indices making them unsuitable for policy analysis. There is also a need to augment the price indices with appropriate coverage of the service prices to improve their overall representativeness,” he said.
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