Inflation & its Measurement in India: Decoded

how inflation is measured in india

How Inflation is Measured in India:

Inflation is usually measured based on certain indices. Broadly, there are two categories of indices for measuring inflation i.e. Wholesale Prices  and Consumer Prices.   There are certain sub-categories for these indices.

 What is an Index Number :

An Index number is a single figure that shows how the whole set of related variables has changed over time or from one place to another.  In particular, a price index reflects the overall change in a set of prices paid by a consumer or  a producer, and is conventionally  known as a Cost-of-Living index or Producer’s Price Index as the case may be.

 Price Indexes / Indices used in India :

In India we use five major national indices for measuring inflation or price levels.

  • The Wholesale Price Index (base 1993-94) is usually considered as the headline inflation indicator in India.
  • In addition to  Whole Price Index ( WPI ),  there are four different consumer price indices which are used to assess the inflation for different sections of the labour force.  These are discussed in more details later on.
  • In addition to above five indices,  the GDP deflator as an indicator of inflation is available for the economy as a whole and its different sectors, on a quarterly basis

Now let us discuss the above indices used in India to measure inflation in detail to understand these better.

Wholesale Price Index (WPI) :  

This index is the most widely used inflation indicator in India.  This is published by the Office of Economic Adviser, Ministry of Commerce and Industry.  WPI captures price movements in a most comprehensive way.   It is widely used by Government, banks, industry and business circles.   Important monetary and fiscal policy changes are linked to WPI movements.  It is in use since 1939 and is being published since 1947 regularly.   We are well aware that with the changing times, the economies too undergo structural changes.   Thus, there is a need for revisiting such indices from time to time and new set of articles / commodities are required to be included based on current economic scenarios.   Thus, since 1939, the base year of WPI has been revised on number of occasions.    The current series of Wholesale Price Index has 2004-05 as the base year.   Latest revision of WPI has been done by shifting base year from 1993-94 to 2004-05 on the recommendations of the Working Group set upwith Prof Abhijit Sen. Member, Planning Commission as Chairman for revision of WPI series.    This new series with base year 2004-05 has been launched on 14th September, 2010.

Earlier, the concept of wholesale price covered the general idea of capturing all transactions carried out in the domestic market.  The weights of the WPI did not correspond to contribution of the goods concerned either to value – added or final use.   In order to give this idea a more precise definition, it was decided to define the universe of the wholesale price index as comprising as far as possible all transactions at first point of bulk sale in the domestic market.

WPI is calculated by Laspeyres Formula in India

This is a relative method which compares the price of the product in question (ie, DVDs) between two different time periods. The first period, called the base period, and a year some point in the future (DVD prices calculated in 2013, and compared to a base period of 2004-05).

For WPI items are classified into three categories:

  • Primary articles
  • Fuel, power, light, lubricants
  • Manufactured products.

Methodology, Basket and Weights Adopted for Revised Index Numbers of  Wholesale Prices in India with Base Year 2004-05 = 100. Thus the latest WPI  has a basket of 676 items with 5482 quotations. The major criticism for this index is that ‘the general public does not buy at the wholesale level’,   thus WPI does not give the actual feeling of the amount of pressure borne by the general public.   However,  the increase in wholesale prices does affect the retail prices and as such give some feel of the consumer prices.

Consumer Price Index (CPI)

The CPI measures price change from the perspective of the retail buyer. It is the real index for the common people. It reflects the actual inflation that is borne by the individual.  CPI is designed to measure changes over time in the level of retail prices of selected goods and services on which consumers of a defined group spend their incomes.   Till January 2012, in India there were only  following four CPIs compiled and released on national level.    (In some countries like UK, Malaysia, Poland it is also known as Retail

Price Index).

(1) Industrial Workers (IW) (base 2001),

(2) Agricultural Labourer (AL) (base 1986-87) and

(3) Rural Labourer (RL) (base 1986-87)

(4) Urban Non-Manual Employees (UNME) (base 1984-85),

The first three are compiled by the Labour Bureau in the Ministry of Labour and Employment, and the fourth is compiled by Central Statistical Organisation (CSO) in the Ministry of Statistics and Programme Implementation.   These four CPIs reflect the effect of price fluctuations of various goods and services consumed by specific segments of population in the country.   These indices did not encompass all the segments of the population and thus, did not reflect the true picture of the price behaviour in the country as a whole.

New Series of CPI Started in 2012

Therefore, there was a strong feeling that there is a need for compiling  CPI for entire urban and rural population of the country to measure the inflation in Indian economy based on CPI.    Thus, now Central Statistics Office (CSO) of the Ministry of Statistics and Programme Implementation has started compiling a new series of CPI for the

  • CPI for the entire urban population viz CPI (Urban);
  • CPI for the entire rural population viz CPI (Rural)
  • Consolidated CPI for Urban + Rural will also be compiled based on above two CPIs

These  would reflect the changes in the price level of various goods and services consumed by the Urban and rural population.   These new indices are now compiled at State / UT and all India levels.

The CPI inflation series is wider in scope than the one based on the wholesale price index (WPI), as it has both rural and urban figures, besides state-wise data. The new series, with 2010 as the base year, also includes services, which is not the case with the WPI series.   However, this new series will become comparable only in 2013 when the data for 2012 will also be available for comparison.

These are indices that measure the average change over time in selling prices by producers of goods and services. They measure price change from the point of view of the seller. Majority of OECD countries measure inflation based on Producer Price Indiex (PPI) while only some others use WPI.  Countries like Japan, Greece, Norway and Turkey use WPI.   Already WPI has been replaced in most of the countries by PPI due to the broader coverage provided by the PPI in terms of products and industries and the conceptual concordance between PPI and system the national account.   PPI is considered to be more relevant and technically superior compared to one at wholesale level.   However, in India we are still continuing with WPI.

 Cost-of-living indices (COLI):  

This is different from CPI.   This index aims to measure the effects of price changes on the cost of achieving a constant standard of living (i.e. level of utility or welfare) as distinct from maintaining the urchasing power to buy a fixed consumption basket of good and services.   Maintaining a constant standard of living does not imply continuing to consume a fixed basket of goods and services. A COLI allows for the fact that households who seek to maximize their welfare from a given expenditure can benefit by adjusting their expenditure  patterns to take account of changing relative prices by substituting goods that have become relatively cheaper, for goods that have become relatively dearer.   The use or preference for a particular goods may also change.

In the long run, the various PPIs, WPIs and the CPI show a similar rate of inflation. In the short run PPIs often increase before the WPI and CPI. Investors generally follow the CPI more than the PPIs. In India WPI is used instead of CPI.

What is Core Inflation :  The concept is used to estimate the inflation by excluding food and energy prices from the basket of goods and services that represents a typical household’s consumption.   In mid 2012, RBI Governor threw up the conundrum posed by this “Core”inflation by saying “In our economy, where food constitutes nearly 50% of consumption basket and fuel has a weight of 15%, can a measure of inflation that excludes them can be called “Core”.   He suggested that India should move towards developing and using a Producer Price Index (PPI) to gauge inflation more accurately as wholesale price index does not capture the price movement of services and is a hybrid of consumer and producer price quotes.

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