Thursday, November 12, 2009

INFLATION: Govt. Figure v/s Reality

Dont we feel that how can inflation be so low or even go negative when we find the prices of all the commodities moving but only upwards...So are the figures released by the Govt. manipulated?? Well now that cannot be possible then why are the figures not representing the actuals... This is what we would like to discuss in this post.

Well Inflation is measured by Price Indices which could be either Wholesale Price Index(WPI), Consumer Price Index(CPI), or Producer Price Index(PPI). What we follow in India is WPI. This WPI is based on the price changes as compared to the base year which in case of India is 1993-94. We take into account the price changes of 435 commodities which are classified under three heads:
  1. Primary Articles- it consist 98 commodities divided into Food items, Non Food Items and Minerals.
  2. Fuel, Power, Light & Lubricant- It has 19 commodities.
  3. Manufactured Products- It consists of 318 commodities.
Each of these commodities are assigned weights so that realtive contribution of each factor is given due importance. The price change is then multiplied with the weights to get the inflation figure. So where does the problem lie??

The first problem is the selection of the base year. The base year has never changed from the time WPI-as a measure of Inflation, was introduced. So it means that the changing dynamics of the economy is not being taken into consideration and therefore this needs to be changed to give a more accurate figure.

The second problem is the weight assigned to each commodites. The weights of the commodities were fixed way back in 1999-00 and has not been touched after that. Now with so many changes in the economy, the weights assigned during those times do not give a true picture in the current scenario. At present Primary articles are assigned 22.025% (of which Food Items consists of 15.4%, Non Food items-6.10% and Minerals- 1.5%), Fuel,Power etc.- 14.226% and Manufactured Products- 63.749%. On the other hand the weight assigned in other measures like CPI is quite different. For example CPI gives Food articles weight between 46%-63% thus giving a more accurate figure of inflation. This explains why in first week of June the inflation as per WPI method was negative while that as per CPI was around 8-10%. Simarily on July 12, 2009 when the infaltion was -1.2% , we never did experience any price decrease, rather we found prices rising. At that time the price change in Food articles were 8.2%, Non Food items -2.7% , Fuel, power etc. -10% & manufactured products -0.05% and as the weight assigned to food items were only 15.4% so it resulted in a negative infaltion though we never experienced any fall in prices. So isnt it clear why in the last three months when the food grains prices soar up by 15-20%, Pulses-60%, Sugar-40%, Tea-25% etc., still the inflation hovered around 1.52%.

So what is the solution to it. Well one of the solutions would be to use CPI as a measure of inflation. According to IMF statistics 24 countries uses WPI and 157 uses CPI. But again we have a problem with it. India had 4 CPIs- Industrial Worker CPI, Agricultural Labourer CPI, Urban Non Manual Employees CPI & Rural Labor CPI and the data is avaliable on monthly and not weekly basis (unlike WPI). So to solve this problem the Govt. needs to adopt the suggestion of National Statistical Org. to streamline the 4 CPIs into a composite CPI like that of the developed countries. This would help in bridging the gap between the Figure quoted by the Govt. and the reality and thereby giving a more genuine picture of the state of our economy.

1 comment:

Prashant said...

Ankit & Paul
This post has given me great insight into inflation and problem related to its calculation...Its really good work...Keep it up....and enlighten people like us...