The Hindu Business Line : Whom does inflation hurt?

Inflation — an increase in the level of consumer prices or a decline in the purchasing power of money caused by an increased availability of currency and credit chasing too few goods — seems to pop up quite often in today’s debates and everyday conversation.

Stripped to its essentials, inflation would indicate a rise in prices as captured by an index consisting of several goods that have weights attached to them. If a particular good has a significantly higher weightage, a change in the price of that good would cause a significant change in the index and thus inflation. If the inflation for a particular week is, say, 5 per cent, it means the index is 5 per cent higher than it was in the same week last year.

What’s the WPI?

The WPI or the Wholesale Price Index is used to measure the change in the average price level of goods traded in the wholesale market. In India, the index consists of 435 items divided into three broad categories: Primary Articles (food, minerals) that have a weight of 22.02 per cent; Fuel, Power, Light and Lubricants that have a weight of 14.23 per cent; and Manufactured Products, which make up the balance of 63.75 per cent.

WPI as an indicator

However, there are a number of problems associated with using the WPI as an indicator of inflation. Economists point out that nearly 100 of the 435 items in the WPI have ceased to be important from a consumption point of view. A commodity such as coarse grain, which goes into the making of livestock feed, is taken into account when calculating inflation, although it may not figure among articles of daily consumption. The WPI doesn’t include prices of the services sector that makes up nearly 60 per cent of the economy today. Over the years, education costs, doctor fees, rentals , and so on, have gone up dramatically, accounting for a significant proportion of the common man’s expenses; but these aren’t captured in official inflation data. What is more, the weightages assigned to various items in the WPI have not been updated as often as they should be. Food items, which make up almost 60 per cent of the consumption basket of the common man, are given only a 22 per cent weightage in the WPI. The last WPI series of commodities was constituted in 1993-94; this underlines the need for a more contemporary barometer to calculate inflation in today’s world. Consumers should also be aware that there is a lag in reporting CPI numbers; the latest figure available today is for May 2007, whereas WPI figures are available on a weekly basis, with a time lag of only two weeks.

Why worry about inflation?

But why should investors worry about inflation? While incomes have been rising for India’s estimated 300 million middle class, fuelling demand for consumer goods, from cars to mobile phones, some 25 per cent of India’s 1.1 billion people continue to live on less than one dollar a day. Everyone realises that inflation makes things more expensive. You have to pay more for the same goods and services. So, if your income doesn’t increase at the same rate as inflation, your standard of living will decline. In other words, inflation reduces your purchasing power. However, it is a mistaken notion that inflation affects all products or consumers equally. It could double the value of some things (such as the recent fuel prices), while keeping the value of other things unchanged.

So whom does inflation hurt the most? Obviously those whose incomes haven’t grown and they have to pay more for the things they buy. Pensioners who depend on fixed interest receipts are a typical example. But there is more to the impact of inflation on the common man. Theoretically, rising inflation favours borrowers over lenders because borrowers, if they borrowed at fixed rates, will have to repay the same amount, despite the lower purchasing power of money. However, most large borrowings nowadays are pegged to floating interest rates (rates that move in tandem with market interest rates). With the central bank trying to curb inflation through interest rate hikes, higher inflation numbers have been accompanied by higher interest rates. If your loans are on floating rates, rising inflation could mean that your loan obligations also bloat in tandem.

(The author is a freelance writer. )

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