Sunday, 22 January 2012

Inflation rate in India

Inflation rate in India

                                                                                                            -Dr. S. Vijay Kumar
               Inflation rate of a country is the rate at which prices of goods and services increase in its economy. It is an indication of the rise in the general level of prices over a period of time. Since it’s practically impossible to find out the average change in prices of all the goods and services traded in an economy (which would give comprehensive inflation rate) due to the very large number of goods and services present, a sample set or a basket of goods and services is used to get an indicative figure of the change in prices, which we call the inflation rate.

Mathematically, inflation or inflation rate is calculated as the percentage rate of change of a certain price index. The price indices widely used for this are Consumer Price Index (adopted by countries such as USA, UK, Japan and China) and Wholesale Price Index (adopted by countries such as India). Thus inflation rate, generally, is derived from CPI or WPI. Both methods have advantages and disadvantages. Since India uses WPI method for inflation calculation, let’s go in to the details of WPI based inflation calculation. First of all let us know how WPI (Wholesale Price Index) is calculated. In this method, a set of 435 commodities and their price changes are used for the calculation. The selected commodities are supposed to represent various strata of the economy and are supposed to give a comprehensive WPI value for the economy.

WPI is calculated on a base year and WPI for the base year is assumed to be 100. To show the calculation, let’s assume the base year to be 1970. The data of wholesale prices of all the 435 commodities in the base year and the time for which WPI is to be calculated is gathered. Let's calculate WPI for the year 1980 for a particular commodity, say wheat. Assume that the
price of a kilogram of whet in 1970= Rs.5.75 and in 1980= Rs.6.10.

The WPI of wheat for the year 1980 is, (Price of Wheat in 1980 – Price of Wheat in 1970)/ Price of Wheat in 1970 x 100 i.e. (6.10 – 5.75)/5.75 x 100 = 6.09.Since WPI for the base year is assumed as 100, WPI for 1980 will become 100 + 6.09 = 106.09. In this way individual WPI values for the remaining 434 commodities are calculated and then the weighted average of individual WPI figures are found out to arrive at the overall Wholesale Price Index. Commodities are given weight-age depending upon its influence in the economy.
Now, let us know, how is inflation rate calculated? If we have the WPI values of two time zones, say, beginning and end of year, the inflation rate for the year will be, (WPI of end of year – WPI of beginning of year)/WPI of beginning of year x 100.For example, WPI on Jan 1st 1980 is 106.09 and WPI of Jan 1st 1981 is 109.72 then inflation rate for the year 1981 is,
(109.72 – 106.09)/106.09 x 100 = 3.42% and we say the inflation rate for the year 1981 is 3.42%. Since WPI figures are available every week, inflation for a particular week (which usually means inflation for a period of one year ended on the given week) is calculated based on the above method using WPI of the given week and WPI of the week one year before. This is how we get weekly inflation rates in India.

Characteristics of WPI:
 · WPI uses a sample set of 435 commodities for inflation     calculation
· The price from wholesale market is taken for the calculation
· WPI is available for every week
· It has a time lag of two weeks, which means WPI of the week two weeks back will be available now

The 435 commodities are divided to various groups and subgroups. Individual commodities, and as a result, groups and subgroups have weight ages. On a broader level, the 435 commodities are grouped into,
1. Primary Articles
2. Fuel, Power, Light & Lubricants
3. Manufactured Products

Primary Articles consist of food grains, fruits and vegetables, milk, eggs, meats and fishes, condiments and spices, fibers, oil seeds and minerals. Fuel, Power, Light & Lubricants consist of coal and petroleum related products, lubricants, electricity etc. Manufactured Products consist of dairy products, atta, biscuits, edible oils, liquors, cloth, toothpaste, batteries, automobiles etc. The group weightages are 22.02525%, 14.22624% and 63.74851% for Primary Articles, Fuel, Power, Light & Lubricants and Manufactured Products respectively. The total adds up to 100.

Instead of the current 435 commodities, the revised WPI will have 980 commodities included in it, which will be rationalized by incorporating new items, removing unimportant items and amalgamating similar items.
Criticism on WPI:
  • There are certain arguments in the open saying that the government shall adopt Consumer Price Index (CPI) method for Inflation calculation, which gives a more correct picture.
  • Some economists assert that method of calculating inflation is wrong as there are serious flaws in the methodologies used by the government.
  • Economists V Shunmugam and D G Prasad working with India's largest commodity bourse -- the Multi Commodity Exchange -- have come out with a research paper arguing that the government urgently needs to shift the method of calculating inflation. Saying that there are serious flaws in the present method of calculating inflation, the paper says India should adopt methodologies in developed economies.
  • India is the only major country that uses a wholesale index to measure inflation. Most countries use the CPI as a measure of inflation, as this actually measures the increase in price that a consumer will ultimately have to pay for.
  • "CPI is the official barometer of inflation in many countries such as the United States, the United Kingdom, Japan], France, Canada, Singapore and China. The governments there review the commodity basket of CPI every 4-5 years to factor in changes in consumption pattern," says their research paper.
  • It pointed out that WPI does not properly measure the exact price rise an end-consumer will experience because, as the same suggests, it is at the wholesale level.
  • The main problem with WPI calculation is that more than 100 out of the 435 commodities included in the Index have ceased to be important from the consumption point of view. For example, a commodity like coarse grains that go into making of livestock feed. This commodity is insignificant, but continues to be considered while measuring inflation. Further, India constituted economists argue the WPI has lost relevance and can not be the barometer to calculate inflation.

  • Shunmugam says WPI is supposed to measure impact of prices on business. "But we use it to measure the impact on consumers. Many commodities not consumed by consumers get calculated in the index. And it does not factor in services which have assumed so much importance in the economy," he pointed out. But why is India not switching over to the CPI method of calculating inflation?
Problems from shifting from WPI to CPI model:
  • Finance ministry officials point out that there are many intricate problems from shifting from WPI to CPI model.
  • First of all, they say, 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, officials say the CPI cannot be used in India because there is too much of a lag in reporting CPI numbers.
To conclude, although there are certain problems from shifting WPI to CPI for the calculation of inflation rate in India, we should do it, because, CPI will give more correct picture of inflation than WPI.

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