Inflation In India: CPI, WPI, GDP Deflator, and Inflation Rate

When India gained independence in 1947, the Indian economy was plagued by low growth, poverty, and resource scarcity. The average Indian’s salary was pitiful. In the 1950s, ask your grandparents how much money they made. An average Indian today earns 100 times more than his grandparents did. Does this imply that people’s living standards have increased 100-fold? Before jumping to this conclusion, keep in mind that the cost of goods and services in the economy has also increased.

A ticket from Delhi to Mumbai used to cost hundreds of dollars, but now it costs thousands. Wheat was similarly priced in Paisa; it cost around Rupee 50/kg. As a result, income does not indicate whether people’s living standards have improved or not.
We need some measure of purchasing power or price to compare your grandparents’ salary to yours. The “Consumer Price Index” is a useful metric for completing the task.

Common Terms Used in Inflation

Consumer Price Index(CPI)

The Consumer Price Index (CPI) is a tool for tracking changes in living costs over time. To maintain the same standard of living, the average Indian family must spend more on goods and services when the CPI rises. Inflation is the economic term for a rise in the price of goods and services. 

Inflation

Inflation is defined as an increase in the overall price level of goods and services in an economy. As a result, the people’s purchasing power is dwindling. For example, if the rate of inflation is 4%, a basket of goods (food, clothing, footwear, tobacco, electricity, and so on) that cost Rs 100 in 2016-17 will cost Rs 104 in 2017-18. We say the value of money/purchasing power has fallen as more money is required to purchase the same basket of goods and services.

Inflation Rate

The inflation rate is defined as the percentage change in the price level from one period to the next. If a normal basket of goods cost Rupee 100 last year and now costs Rupee 120, the rate of inflation this year is 20%.

Inflation Rate= {(Price in year 2 – Price in year 1)/ Price in year 1} *100

Wholesale Price Index(WPI)

WPI stands for Wholesale Price Index and is used to track the cost of goods and services purchased by producers and businesses rather than end-users. WPI inflation measures changes in the factory and wholesale prices. The WPI and CPI are two different indices with different applications.

The WPI and CPI calculate inflation using different baskets of goods. Food, fuel, manufacturing items, and other items are given different weights. For example, the weight of food in the CPI is 46 percent higher than in the WPI, which is 24 percent. The WPI does not account for changes in service prices, but the CPI does.

GDP Deflator

GDP Deflator is yet another important metric for calculating people’s standard of living. The GDP Deflator is the nominal GDP to real GDP ratio. Real GDP is calculated using base-year prices, whereas nominal GDP is calculated using current prices. As a result, GDPDeflator reflects current prices in comparison to prices in a base year. In India, for example, the base year for calculating deflators is 2011-12.

Producer Price Index

The Producer Price Index (PPI) tracks the average change in the sale price of goods and services as they leave or enter the manufacturing process. It calculates the change in the average price received by the producer. PPI is a price index that measures the average change in prices received by producers, excluding any indirect taxes. Furthermore, PPI includes services.

The PPI compares price changes from the seller’s perspective to the CPI, which compares price changes from the buyer’s perspective.

National Housing Banks (Residex)

It is India’s first housing price index, and it was created by the National Housing Bank at the Ministry of Finance’s request. The Technical Advisory Committee assisted in the creation of the index. It was first released in 2007 and is updated on a regular basis, with 2007 as the base year. The Residex network now covers 26 cities.

NHB RESIDEX was first calculated using market data, but since 2010, it has relied on valuation data from banks and housing finance companies (HFCs). From 2013 to 2015, data were obtained from India’s Central Registry of Securitization Asset Reconstruction and Security Interest (CERSAI).

Under the NHB RESIDEX brand, the scope has been expanded to include housing price indices (HPI), land price indices (LPI), and building materials price indices (BMPI), as well as housing rental indexes (HRI).

Measurement of Inflation in India

• So due to the high base effect in 2013 (120), the rate of inflation is lower in 2014.
• Similar case for 2014
• So base effect is related to the previous year, not the base year.
• Because of the high base effect, inflation becomes low.

In India, inflation is calculated using both the WPI and the CPI. WPI is used to forecast the current rate of inflation, which is referred to as headline inflation; however, CPI is also used to measure inflation and is used to calculate government Grand Dearness Allowances (DA). The WPI is compared to the base year 2004-05 using 676 commodities. It is built on the basis of wholesale prices for these commodities, which are gathered from India’s major wholesale markets.

These commodities are divided into three categories: manufactured goods, primary and food products, fuel, light, and electricity. Manufacturing articles account for nearly 65% of the weight in this index. Food and primary articles account for 20% of the weight, while fuel, light, and electricity account for 15%. This index is a commodity-only index with no service representative index. Its inflation is driven primarily by food and primary goods inflation, which is common in India, and this index gives these items very little weight. India is the only country that uses the WPI to calculate inflation rates.

Inflation is also measured using the CPI. In 2011, a new CPI was introduced to replace the old CPI (CPIIW). The new CPI is known as CPI (N) (Notional), and it is created by combining the CPI ® (Rural) and CPI (U) (Urban) indexes.

This index is created by the CSO (Central Statistical Organization), whereas the WPI is created by the Office of the Economic Advisor DIPP (Department of Industrial Policy and Promotion). The Consumer Price Index (N) is calculated using data from NSSO consumer expenditure surveys. Unlike the WPI, this index is based on retail prices. It is built by considering five broad categories of commodities: food and beverages, clothing and footwear, housing, fuel and light, and tobacco and other toxicants.

Miscellaneous is also included. Banking, insurance, entertainment, telecom, transportation, and other services are included in this index. Food and beverages account for nearly 46% of the index, making it more representative of inflation, which is more pronounced in food items. CPI (N) is based on the year 2011. There is often a divergence between WPI on CPI which is mainly due to-

• The difference in the base year
• Weightage of food articles
• Wholesale & retail prices
• Inclusion/exclusion of service

Most advanced countries have switched to using the PPI – Producer Price Index, which is an index based on prices received from producers and does not take into account three losses: transportation costs, indirect taxes, and trader profit margins.

The goal of such an index is to address rising prices by taking corrective measures at the producer level before they reach the consumer. Under Goldhar’s leadership, an expert committee has been formed in India to assess the feasibility of constructing PPI to replace WPI.

Causes of inflations

Inflation is caused by two types of factors, known as demand-pull and cost-push factors, in any country. Demand-pull factors are those that cause an increase in overall demand for goods and services in general, while cost-push factors cause an increase in overall production and distribution costs and/or supply shortages. Demand-pull factors can be more powerful than cost-push factors at any given time, and vice versa. Prominent demand-pull factors in India are as follows-

• Rising population
• The rise in income and wages
• Fast-changing consumption patterns in favor of high protein foods
• Increase in government expenditure particularly non-planned
• Increase in money supply/deficit financing
• Increase in forex reserve

Prominent cost-push factors in India are-

• Infrastructural battle necks
• Rising administrated prices
• Hoarding & speculation
• Seasonal factors
• The rise in income and wages
• Import cost-push factors

Measures to control inflation

There are 3 types of policy measures adopted to control inflation in India. These are as follows.

• Monetary policy
• Fiscal policy
• Administrative measure

Monetary Policy

The RBI’s monetary policy entails the use of a quantitative-qualitative credit control measure from time to time, in which it adopts a dear money policy during inflation by raising key policy rates like the repo rate and CRR more frequently. The goal is to limit banks’ lending capacity and people’s borrowing in order to reduce demand, which would otherwise fall due to high-interest rates. However, the role of monetary policy in controlling inflation is limited, as it is only effective when inflation is higher due to the demand-pull factor, as monetary policy plays a little role on the supply side.

Fiscal Policy

This policy entails the use of government spending and taxation, as well as the government’s occasional fiscal deficit. In terms of government spending, it is primarily non-planned spending that leads to an increase in demand without corresponding production, which the government finds difficult to control and is primarily responsible for the fiscal deficit.
As a result, indirect taxation is the only effective tool the government has for controlling inflation. Import duties on essential commodities such as crude edible oil, pulses, butter, hydrogenated oil, and even wheat and rice are frequently reduced by the government to keep prices stable.

In recent years, it has also significantly reduced import duties on onion when the country faces a domestic shortage – in addition, it has implemented a selective reduction of excise duty on some essential commodities to help control inflation, as high indirect taxes contribute to rising prices. As a result, even fiscal policy has a limited role to play, and the government, on the whole, prefers to use a large number of administrative measures, such as the following:

• Imposing a ban on the export of non-Basmati rice edible oil and pulses from time to time.
• Fixation of a Minimum Export Price (MEP) for onions and Basmati rice below which these can export.
• Imposing a temporary ban from time to time on exports of onion.
• Imposing a ban on future treading in some essential commodities like rice, potatoes, and some categories of pulses as and when such trading may threaten domestic supplies.
• Placing origin and potatoes under essential commodities act to ensure fair distribution of these commodities & prevent hoarding and speculation so that any violation thereof is treated as a non-billable offense.
• Moderating increases in MSP of some of the essential crops to spend signals of moderation in the free market.
• Invoking the provisions of ESMA (Essential Service Maintenance Act) under which Government imposes a ban on strikes in essential services like those of truckers transporters and distributors prevention.
• Strengthening the provision of anti-black marketing and hoarding act under which summary and fast track punishment may be provided to those indulging in such practices.
• Conducting frequent raids on godowns of big traders of essential commodities to unearth hoarded stocks.
• A price stabilization fund with a corpus of Rs 500cr has been set up to fight conditions of drought.
• The state has been advised to remove perishable commodities such as fruits and vegetables from the scope of the state government’s APMC acts, resulting in a near-monopolistic market for agricultural produce in India.
• Strengthening and broadening the scope of PDS by involving NAFED and state-level agencies in the door-to-door distribution of some essential commodities at very low prices in order to protect vulnerable groups from rising prices. In this regard, the government occasionally releases additional wheat and rice supplies for open free market sales.

The above measures primarily address the issues of availability and distribution, but they do not address the issue of production, which necessitates massive investments in agriculture, not only to increase productivity but also to reduce reliance on the monsoon. Aside from changing consumption patterns, increased investments in increasing the production of commodities that are part of the changing consumption pattern are also required.

Another important measure that can have a long-term moderating effect on prices is to allow FDI into multi-brand retail. The biggest benefit projected by policymakers is that it would reduce the role of middlemen and intermediaries, whose high margins are often responsible for high prices for consumers. Last but not least, there is a pressing need for a national agricultural commodities market to replace the fragmented markets that existed under the state APMC Act.

This would ensure perfect competition in the agricultural market, allowing even private traders to set up markets to compete with the state-regulated markets, which number in the thousands.

Inflation Targeting

This means that a country’s Central Bank sets a specific target rate of inflation or a specific target increase as a primary goal of its monetary policy and then examines its monetary policy to stay within that target. In 1989, New Zealand became the first country to have its central bank adopt inflation targeting, and most advanced countries, as well as some developing countries, now have inflation targeting as their primary goal.

In India, the RBI decided to adopt inflation targeting based on the recommendations of the Urjit Patel Committee, which was established a few years ago. Initially, the RBI would target a rate of inflation of no more than 6% by January 2016 based on CPI. According to the committee’s recommendations, the RBI should aim for an annual rate of inflation of 4% with a 2 percent plus or minus the band.

The RBI and the Indian government will share responsibility for inflation targeting in India. While the RBI will be in charge of the demand side, the government will be in charge of the supply side and the fiscal deficit in order to meet the target. For the purpose of monetary variables, a monetary policy committee will be established.

If the rate of inflation exceeds the target set for three consecutive quarters, the RBI must provide adequate reasons and explanations to justify any corrective action that may be taken.

Philips Curve

This curve is named after AW Philips, who theorized that there is a link between an economy’s inflation rate and its unemployment rate. Inflation and unemployment have an inverse relationship in that if inflation is low, unemployment is likely to be high, and vice versa. A country can choose between a low rate of inflation and a high unemployment rate, or a high rate of inflation and a low unemployment rate.