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How exactly India calculates ‘Inflation’?

Updated: Nov 14, 2019


You must have heard news like “CPI inflation hits a 39-month high at 6.5%” in some of the leading news channels. Have you ever wondered what exactly does it mean or how it affects the Indian economy?

Well, you need to give time to understand two very important indexes which drive the market in either direction. Inflation plays is a vital role in any country’s economic growth and helps to project future scenarios. Inflation is a general and sustained increase in the overall price level of goods and services. The inflation rate is a key parameter basis which central government proposes its monetary and fiscal policy from time to time. The monetary policy primarily focuses on price stability and hence its concern for inflation is rather obvious.

In India, generally, two kinds of indices are used to measure inflation —

1) Wholesale Price Index (WPI

2) Consumer Price Index (CPI).

What is the Wholesale Price Index (WPI)?

An index used by the Reserve Bank of India till 2014 to make its monetary policy, WPI, as the name suggests, measures the prices at the wholesale level. WPI is the price of a representative basket of wholesale goods. It takes a basket of 697 items into account and shows the combined prices.WPI is divided into three groups: Fuel and Power (13.2 percent), Primary Articles (22.6 percent of total weight) and Manufactured Products (654.2 percent).

How is WPI (Wholesale Price Index) calculated?

In this method, a set of 697 commodities and their price changes are used for the calculation. The selected commodities are supposed to represent the various loss 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 697 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 wheat 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.

The main reason RBI, under ex-governor Raghuram Rajan, shifted to Consumer Price Index is because it neglects services and the bottlenecks between a wholesaler and a retailer.

What is the Consumer Price Index (CPI)? CPI, based on 260 commodities including certain services, measures the change in prices at the retail level.

The most important category in the consumer price index is Food and beverages (45.86 percent of total weight), of which Cereals and products (9.67 percent), Milk and products (6.61 percent), Vegetables (6.04 percent), Prepared meals, snacks, sweets, etc. (5.55 percent), Meat and fish (3.61 percent), and Oils and fats (3.56 percent). Miscellaneous accounts for 28.32 percent, of which Transport and communication (8.59 percent), health (5.89 percent), and education (4.46 percent). Housing accounts for 10.07 percent; Fuel and light for 6.84 percent; Clothing and footwear for 6.53 percent; and Pan, tobacco and intoxicants for 2.38 percent.

Prices of sample goods and services are collected periodically (usually every month) by the Ministry of Statistics and Programme Implementation, and the change, if any, is noted.

The base year of CPI was changed to 2012 from 2010. Base year for WPI and IIP (Index of Industrial Production) was also changed to 2012 in April this year.

A base year is used to compare the measure of rates. For simple understanding, this can be taken as ‘first’ year in the time set. Prices in the base year are often taken as 100 to simplify calculations. Inflation is the measure of the rate of increase in the prices of goods and services. However, when there is a decrease in the rate it is called deflation. Authorities in India use price indices to determine the change of rates of commodities and services, thus the inflation or deflation is calculated.

For example, if the rate of rice a year ago was Rs 20 a kilo and currently it is Rs 22 a kilo, the inflation in the rice prices would be at 10 percent. The overall inflation also called the Headline Inflation is measured taking into account the rise in food, fuel, and other commodities. While calculating inflation, the weight of a product is considered higher if consumers expend a larger share of their income on that product.

For example, household expenditure is higher on food and fuel than postcards or shaving creams, hence given more weights while calculating the inflation. Ergo, the impact of the change in food or fuel prices is greater on inflation than the same change in shaving cream.

So, How is the 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 the year — WPI of the beginning of the year)/WPI of the 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%.

The retail inflation rate in June is 1.54 percent, the lowest in the last 18 years. The lowest inflation rate, technically deflation, was recorded in May 1976 at (-)11.31 percent. On the other hand, the highest inflation rate observed was 34.68 percent in September 1974.

Thanks! Akshay Seth Research Analyst (SEBI Regd.) akshay.equity@gmail.com Linkedin: connect here

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