Inflation is a politically sensitive

subject but few understand the

calculation methodology. In

addition to complex methodology,

inflation data gathering is suspect.

There are always multiple

revisions to the preliminary

numbers and the changes may be

of large dimensions.

The market responds to

the preliminary number and if

that is out of kilter, the market

response may seem irrational

in hindsight. The Wholesale

Price Index (WPI) is the chief

gauge of inflation in India.

The Indian Consumer Price

Index (CPI) is taken less

seriously. The RBI also

calculates “core inflation”,

excluding volatile energy and

food prices from WPI.

The year-on-year change

in WPI is used as the rule of

thumb method for calculating

the inflation rate. YoY is

deceptive if the base month

had exceptionally low or high

inflation. It also doesn't yield

a sense of the average

inflation rate.

The recently released data

included a few points worth

noting. The December 2012

WPI showed a YoY change of

7.2 per cent, which was the

lowest rate in over two years.

The revised data for October

2012 was 7.3 per cent, which

is lower than the preliminary

estimate of 7.45 percent. This

suggests WPI is indeed falling.

A look at the WPI series itself,

rather than changes in its

values, also shows a flattening

line. Out of the WPI

components, manufactured

goods rose just 5 per cent.

However, commodities

(primary goods) are priced

high at 10.6 per cent and fuel

is at 9.4 per cent.

There was a big

discrepancy when comparing

WPI to the CPI numbers. CPI is

running at 10.56 per cent,

which is the highest it's been

since the current series was

initiated in Jan 2011. Food is

up 13 per cent and clothing

and housing are both up by

over 10 per cent. So, the aam

aadmi is struggling to cope

with the high prices of roti,

kapda and makaan. Rural CPI

is also higher than urban CPI,

which is even worse news

politically.

The stockmarket rejoiced

when the WPI data came in.

Coupled to a weak November

2012 Index of Industrial

Production, it's seen as ample

justification for a policy rate cut

when the RBI reviews the

Credit Policy on January 29. As

a result of his guesswork, a

host of rate sensitive stocks

have shot up. The central bank

does however, have a

responsibility to balance

growth and control inflation.

The high CPI numbers and

their political significance

might make it hesitate to

loosen up.

On balance, the RBI is

likely to cut repo, I think. But it

may be a minimal 0.25 per

cent cut. This would be

discounted before the credit

policy was announced. That

might make it a “buy on

rumour, sell on news” situation

where stocks actually react

downwards when the cut

occurs.