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Inflation
- Inflation is basically the general rise in the price of goods and services and the decline in purchasing power of people.
- This means that when inflation rises (without an equivalent rise in your income), you are able to buy lesser things than you could buy previously, or you have to pay more money for the same stuff now.
- A “rising” inflation rate implies that the rate (at which the prices rise) itself is increasing.
- In other words, imagine a scenario where the inflation rate was 1% in March, 2% in April and then 4% in May and 7% in June.
Measuring Food Inflation in India
- Any price index can in principle be calculated using producer, consumer, or wholesale prices, with each serving a different purpose.
- Price indices are used to measure the average change over time in selling prices received by producers (producer price index inflation), or prices paid by consumers (CPI inflation), or the average price change in the wholesale market (WPI inflation).
Wholesale Price Index
- Wholesale Price Index, or WPI, measures the changes in the prices of goods sold and traded in bulk by wholesale businesses to other businesses.
- Wholesale market is only for goods, one cannot buy services on a wholesale basis.
- It is used to track the supply and demand dynamics in industry, manufacturing and construction.
- The index is released by the Economic Advisor in the Ministry of Commerce and Industry every month.
- The quantum of rise in the WPI month-after-month is used to measure the level of wholesale inflation in the economy.
How is WPI calculated?
- The index is based on the wholesale prices of number of relevant commodities available.
- The commodities are chosen based on their significance in the region.
- These represent different strata of the economy and are expected to provide a comprehensive WPI value.
- Number of commodities: 697 items
- Base year: 2011-12
Major Components of WPI
- ‘Primary articles’ (22.62%) is a major component of WPI, further subdivided into Food Articles and Non-Food Articles:
- Food Articles: Cereals, Paddy, Wheat, Pulses, Vegetables, Fruits, Milk, Eggs, Meat & Fish, etc.
- Non-Food Articles: Oil Seeds, Minerals and Crude Petroleum.
- The next major basket in WPI is Fuel & Power (13.15%), which tracks price movements in Petrol, Diesel and LPG.
- The biggest basket is Manufactured Goods (64.23%). It spans across a variety of manufactured products such as Textiles, Apparels, Paper, Chemicals, Plastic, Cement, Metals, and more.
- Manufactured Goods basket also includes manufactured food products such as Sugar, Tobacco Products, Vegetable and Animal Oils, and Fats.
Headline and Core Inflation
- Headline inflation refers to the change in value of all goods in the basket.
- Core inflation excludes food and fuel items from headline inflation.
- Since the prices of fuel and food items tend to fluctuate and create ‘noise’ in inflation computation, core inflation is less volatile than headline inflation.
- Headline inflation is more relevant for developing countries like India where fuel and food items account for 30-40% of the basket.
The Consumer Price Index (CPI)
- It’s a measure of the average price changes in a basket of goods and services commonly consumed by households. The CPI is based on 260 commodities and certain services.
The CPI is used to:
- Target inflation
- Calculate Dearness Allowance
- Serve as a deflator in the National Accounts
- The Monetary Policy Committee is required to keep the CPI in the range of 2% to 6%.
- The CPI is compiled and computed by the Central Statics Office (CSO). The indices are compiled at State/UT and All India levels and are based on 2012 as the base year.
The CPI is closely followed by:
- Policymakers, Financial markets, Businesses, Consumers.
Difference between WPI and CPI
- While WPI keeps track of the wholesale price of goods, the CPI (Consumer Price Index) measures the average price that households pay for a basket of different goods and services.
Why Reserve Bank of India Adopted CPI over WPI?
- On the recommendation of the Urjit Patel Committee (2014), the RBI adopted CPI as the key measure of inflation. Earlier, RBI had given more weightage to WPI as the key measure of inflation for all policy purposes.
- CPI focuses on the change in the cost of living at the consumer’s end, whereas the WPI focuses on the inflation of the economy as a whole.
- For common people, i.e. consumers, it is the CPI that is more relevant than the WPI. CPI also covers the service sector.
- Through CPI, the RBI can increase the span of monetary control and monitor inflation better.
- Therefore, the RBI linked CPI for fixing interest rates in India.