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How does inflation affect common man’s palate?
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If you thought lower inflation numbers would bring some respite for your ever-depleting pockets, think again.
Amidst all the hoopla surrounding the ‘ever-so-important’ inflation numbers, what do they signify for the ‘aam admi’ of India? If you thought lower inflation numbers would bring some respite for your ever-depleting pockets, think again.
With so much buzz around inflation, let's dwell on it a little more. Broadly, there are two measures of inflation - rate of change of Wholesale Price Index (WPI) and Consumer Price Index (CPI). While the former measures rates of goods that take place in the wholesale market over a period of time, the later, also known as cost of living index, is a measure of prices of goods and services at the consumers' level. As WPI focuses on the wholesale prices, it fails to capture the consumption pattern of consumers, which should ideally be the factor to formulate monetary policies.
Emergence of WPI and CPI
WPI was first published in 1902, and was one of the more efficient economic indicators available to policy makers globally. However, the index was renounced by most countries in the 1970s as soon as CPI came into the picture. Every major economy today uses the CPI for calculating inflation with India being the only country which still relies on the age-old tool as ancient as the medieval times. The fact that is even more deplorable is that even the crisis-hit Pakistan uses CPI.
Loopholes in WPI
In India, a total of 435 commodities data on price level is tracked through WPI, which is an indicator of movement in prices of commodities in all trade and transactions. The problem, however, is that about 100 out of the 435 commodities included in the index are no longer important from the consumption point of view. For instance, a commodity like coarse grains that goes into making of livestock feed finds itself among the articles considered for inflation, although it has grown insignificant in today’s date.
|
Weighting Pattern of WPI |
|
|
Weights in2004-05 |
|
|
All commodities |
100.0 |
|
I. Primary Article |
20.1 |
|
(A) Food Articles |
14.3 |
|
(B) Non-Food Articles |
4.3 |
|
(C) Minerals |
1.5 |
|
II. Fuel Power Light & Lubricants |
14.9 |
|
A. Coal Mining |
2.1 |
|
B. Minerals Oils |
9.4 |
|
C. Electricity |
3.5 |
|
C. Manufactured Products |
65.0 |
|
(A) Food Products |
10.0 |
|
(B) Beverages Tobacco & Tobacco Products |
1.8 |
|
(C) Textiles |
7.3 |
|
(D) Wood & Wood Products |
0.6 |
|
(E) Paper & Paper Products |
2.0 |
|
(F) Leather & Leather Products |
0.8 |
|
(G) Rubber & Plastic Products |
3.0 |
|
(H) Chemicals & Chemical Products |
12.0 |
|
(I) Non-Metallic Mineral Products |
2.6 |
|
(J) Basic Metals Alloys & Metals Products |
10.7 |
|
(K) Machinery & Machine Tools |
8.9 |
|
(L) Transport Equipment & Parts |
5.2 |
Another major limitation of the WPI is that the concept of wholesale price is not defined clearly. As noted by the National Statistical Commission, “owing to the wide variety of sources, centres, and specifications and due to the practical compulsion of collecting data by the voluntary method, it is difficult to maintain uniformity in the concept of wholesale price in the collection of price data. In many cases, these prices correspond to farm-gate, factory-gate or mine-head prices; and in many other cases they refer to prices at the level of primary markets, secondary markets or other wholesale or retail markets”.
Additionally, services sector, which contributes over 60% of India’s GDP, is not considered to be important enough for determining inflation by the WPI method. Moreover, the provisional figures released initially undergo substantial revision subsequently, which makes it all the more complex for use in the conduct of monetary policy.
“Easier data collection is the primary reason why it is used. There are some disadvantages in utilising WPI data. For example, WPI poorly reflects the cost of living because it does not focus on the prices at which the consumer is purchasing the goods”, says Anis Chakravarty, Director Deloitte Haskins & Sells.
Also, WPI does not reflect the true scenario of inflation feels Chakravarty. “Measuring inflation at stages of production also does not provide an accurate reflection of the market pressures and the inflation scenario. Further, WPI measures price change at the wholesale and manufacturing level and does not consider retail margins. Therefore, it does not reflect the actual price hike which the consumer is facing. It is also important to note that economic data such as employment and housing sales are not regularly compiled, hence inflation movements in these areas are not tracked adequately“, he adds.
CPI over WPI
CPI uses defined basket of goods and services that represent purchasing pattern of a particular household. Since this is driven from the consumption side, it provides a relatively realistic view on how consumers are affected. Therefore a reliable indication of demand side pressures and inflation is received from utilising CPI as a measure.
Some of the notable differences between the two indices are: CPI gives a 46.2% weightage to food and food products, while manufactured products account for a much lower weight, making it more citizen-friendly index. Fuel and light products weigh around 15% in WPI while in the CPI, they weigh between 6.4 and 7.9%.
“However, the most common flaw in CPI is the difficulty in data collection”, says Madan Sabnavis, Chief Economist, CARE Ratings. “CPI is a tricky concept because we have heterogeneous groups of people as well as different prices at different places. While manufactured goods sell at the same price, food prices vary differently across states. Also, different people in different classes have differing consumption patterns. This is why while we have CPIs, there is no single CPI that we can have for the country that captures the consumption pattern of all people” Sabnavis adds.
However, if data collation is improved by way of electronically linking food prices from mandis, the problem could be eradicated to an extent. “Mandatory reporting from factory sector will also enhance the quality of data”, adds Sabnavis.
Problems in shifting to CPI
Even the RBI Governor D Subbarao said that "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."
So, if even the RBI Governor acknowledges the superiority of CPI over WPI, what is stopping the government to switch over?
Firstly, in India, there are four different types of CPI indices, and that makes switching over to the Index from WPI fairly 'risky and unwieldy.' The four CPI series are: CPI Industrial Workers; CPI Urban Non-Manual Employees; CPI Agricultural labourers; and CPI Rural labour. Secondly, CPI cannot be used in India because there is too much of a lag in reporting CPI numbers.
Government meddling
Kirit Parikh, Director, Indira Gandhi Institute of Developmental Research had once said that "inflation at this level is stage-managed with the specific purpose of fighting the elections. The Government has postponed many of its decisions on the price front." So, there might be a possibility that the government is deliberately trying to keep away from CPI, as it might shoot inflation higher from the already sky-rocketing levels currently.
However, contradicting this view, Sabnavis says that “Government is not irresponsible to tamper with the data for short term gains. For lowering inflation for political expediency, it can always import cheap sugar or wheat and induce in the market to cool prices. But this is a cogent economic policy and not stage managing things.”
Conclusion
CPI is a better way to compute the inflationary trends. It is important that measures are taken such that some level of service data can be utilised. Secondly, it is important that instead of wholesale data, transactional data is utilised to provide a reliable indication of how price movements affect consumers.
Hopefully, the day will come soon when Government will take care of the real issues in inflation measurement. Till then, we have no option but to carry the burden of legacy and wait for next round of policy decisions.