Mumbai: Reserve Bank Governor D Subbarao on Tuesday said consumer price index (CPI) works better than wholesale price index (WPI) in capturing market dynamics and arriving at a more realistic inflation forecast.
"Conceptually, the CPI is a better indicator of demand side pressures than the WPI… and there is no denying that consumer prices better reflect demand side pressures than wholesale prices," Subbarao said at the RBI's 5th Statistical day celebrations at the Mint Road office.
Elaborating it, the Governor said a sustained rise in wholesale prices either results in an eventual increase in prices by retailers or a squeeze in their margins.
But if the demand is strong, retailers may exercise pricing power and pass on the increase in wholesale prices to consumers. In case demand is weak, retailers will be forced to partly absorb the increase in wholesale prices in their margins, he said.
However, defending the WPI usage in the apex bank's inflation forecast, Subbarao said, "Given the limited efficacy of monetary policy to deal with food and fuel inflation, and the limits on using core CPI inflation measures, we have focussed our attention on non-food manufactured products inflation as an indicator of demand-side pressures in the economy."
He admitted that there was some merit in the criticism of RBI's inflation forecasts, which has been going off the mark, but pointed out that the bank has "opted for WPI over CPI as a second best choice for a number of reasons, first and most importantly, we do not have a single CPI that is representative of the whole country.
"Until recently we had four, and currently we have three CPIs representing different segments of the population," he said, pointing out that while WPI is computed on an all-India basis, while CPIs are constructed for specific centres and then aggregated to an all-India index.
"Secondly, WPI is available with a shorter lag than the CPIs. Third, WPI has a broader coverage than the CPIs in terms of the number of commodities, quotations, inclusion of non -agricultural products and tradeable items," he said.

Subbarao blamed the inflation miscalculation to a range of factors from escalation in oil and commodity prices, below- expectations decline in food prices despite a normal monsoon, erroneous signals from IIP data, and upward revision in the past inflation data.
He said private inflation forecasts came much closer to actual number reported for last fiscal year.
Noting that the revision of the basket for CPI series lags that of the WPI series, he said though last year when the WPI series was revised to the base of 2004-05, the existing CPIs continues with the old base- for CPI-RL (rural labourers) (1986-87), CPI-AL (agri-labourers) (1986-87) and CPI-IW (industrial workers) (2001), making them ill-equipped to capture the price behaviour caused by the rapid structural changes in the economy.
Pointing out that changes in the weights for manufactured products are not substantial even in the revised WPI base year, he said there was a tilt in the weights towards non-food manufactured products, reflecting changes in the production pattern over the decade.
Some key economic data widely used elsewhere, such as regular retail sales data, as well as those on employment and housing sales, are not regularly compiled in the country, leading to inflation numbers that are half baked or non-representative of the actual demand and price movements in the economy.
Pointing out that the more critical data on WPI inflation has also been subject to large revisions, he said, "the initial estimates of WPI inflation were 8.2 percent for January '11 and 8.3 percent for February'11. (But) both these numbers were substantially revised upwards by 120 bps each."
"Often, it is not clear if the revisions are occasioned by one-off factors or systemic factors. Nevertheless, each time we have to make an assessment of the inflation situation, we are left to double-guessing how the provisional number might be revised," Subbarao said
"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 concluded.