The Hindu Business Line : Calibrating the inflation meter

People’s income has changed, and so has their consumption pattern. This recognition is essential as we move towards an improved Consumer Price Index.

Lakshmi Kumar

The debate over WPI (wholesale price index) vs. CPI (consumer price index) has grown in the past few months with inflation creeping up week after week before showing a downward trend.

The WPI is used as a measure of inflation in India, although it has been argued time and again that the CPI is a better indicator. The lack of adequate machinery to measure the CPI sees us continuing with the WPI, which on closer examination shows tha t it does not include a lot of items consumed in India today.

The differences

The WPI is an indicator of the movement in wholesale prices of 435 commodities. It is the only price index available weekly, with the shortest time lag of two weeks, making it widely used in business and industry circles as well as the Government. The base year of the WPI series is 1993-94.

On the other hand, the CPI for industrial workers — CPI (IW) — is constructed on a monthly basis, with a lag of one month. CPI measures changes in the retail prices of goods and services covering 260 items from 70 centres. The base year for the CPI (IW) is 1982.

The WPI and CPI (IW) series differ significantly in terms of weights. This implies that the degree of importance given to specific commodity groups is not the same in the two series. While food gets the maximum weight of 57 per cent in the CPI (IW) series, it gets only 27 per cent in the WPI series. The CPI (IW) series is therefore more sensitive to changes in food prices.

The fuel group, on the other hand, gets a much higher weight in the WPI series (14.23) compared to the CPI (IW) series (6.28).

International price movements of crude oil would therefore have a greater bearing on the WPI series in terms of direct impact. One major subgroup in the CPI (IW) series is the miscellaneous group which includes services such as transport, education, health and so on. Services, a major contributor to the GDP, however does not get reflected in the WPI series.

Therefore, the differences in the inflation rate between the two series could also be on account of price movement in the services sector, which gets captured in the CPI (IW).

Getting it right

While it is obvious that the CPI is a better indicator of inflation than WPI, one wonders whether the constituents of CPI reflect the consumption basket of the present generation.

The CPI composition has not changed since 1988, while the people’s consumption basket has. For instance, there were no mobile phones in 1988. Today, mobiles phones are commonly used even in rural areas.

Consequently, it might be more useful to look at trends in the Private Final Consumption Expenditure (PFCE). A comparison (see table) shows there are significant differences in the items and their weights between the constituents of CPI and PFCE. The latter reflects the changes in the consumption basket, as it also includes FMCG products. However, more important is the differences in the weights assigned to the different categories.

Food and related items seem to have lesser weight and have been reducing (51 per cent to 40 per cent) since 1999, but remain as high as 60 per cent in the CPI. Obviously the weight assigned is too high. When we compare the two series we realise that the weight assigned to food has come down but the weight for other items need to increase in line with the changing consumption patterns.

With higher incomes it is but natural to consume a variety of goods, and though food consumption may go up, its relative importance in a family’s budget has come down.

Another interesting fact about the table is that the miscellaneous category under the CPI has a weight of about 16 per cent while it is about 44 per cent in the PFCE. Medical care, education, transport and communication have been high consumption categories in the past few years and, naturally, expenditure on these has gone up.

Also, FMCGs have been recognised in PFCE as an important component of a family’s expenditure, whereas CPI does not recognise it as a separate category.

Without doubt, the PFCE appears to be a better reflection of our times, and while we move towards CPI from WPI it would be useful to use PFCE to assign weights to the different categories.

People’s income has changed, and so has their consumption pattern. This recognition is essential as we move towards an improved CPI. Additionally, these weights can be changed each year by gathering information on the present final consumption expenditure.

(The author is faculty member, Institute for Financial Management and Research. blfeedback@thehindu.co.in)

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