India has been passing through a low inflationary regime for the past nine months. Still the RBI Governor mentions about the inflationary concern and hence an eligible rate cut was denied to the society. Common people agree with the Governor for his former attitudes were as the corporate sector express unrest towards his stand about interest rate cut. The reality felt by the common man and official numbers relating to inflation do not go hand in hand. How can we explain this?
Inflation- WPI and CPI based Estimates
India adopted Wholesale Price Index (WPI) to measure inflation till 2014. Thereafter the country shifted to CPI (combined) based inflation. We also separately measure CPI for rural and urban. The main reason for shifting to CPI is that it is the widely used measure at international level.
The differences between the WPI and CPI are a result of the different items that are included in each measure and the weights. WPI excludes services such as education, healthcare, and rents which account for nearly 60 per cent of GDP. The new CPI measure assigns 36 per cent weightage on services .It includes price changes in housing, education, healthcare, transport and communication, personal care and entertainment.
The second difference is the change in base year. The base year was shifted from 2010 to 2012 for the calculation of CPI but 2004-05 is continued for the calculation of WPI. The weight of food items is another difference between the two measures of inflation in India. Along with the change in base year, there was tweaking in the weights of some food and non-food items. Earlier, food items—including food grains, fruits, vegetables, milk, eggs, meat, fish, condiments, spices, tea, and coffee—accounted for 14.34 per cent of the WPI. In contrast, they made up 39.73 per cent of the CPI. Food, beverages, and tobacco made up 49.71 per cent of the CPI. Hence, no doubt that CPI is more susceptible to changes in food prices than the WPI. Also, higher transaction costs and taxes are only reflected in the CPI.
Weights of various items in CPI would be based on the consumption expenditure survey of 2011-12, against 2004-05 used earlier. The number of items was increased from 437 to 448 in rural areas and from 450 to 460 in urban areas. The rural CPI gives a weight of 54.18 per cent to food items but the urban CPI gives a weight of 36.29 only so that the weight in the CPI combined drops to 45.86.It means that it makes up less than half the index (see table.1).
The weights assigned to various categories under CPI (combined)
|Existing Weights(2004-05)||New Weights(2011-12)|
|Food and beverages||47.58||45.86|
|Fuel and light||9.49||6.84|
|Clothing and Footwear||4.73||6.53|
|Pan, tobacco and intoxicants||2.13||2.38|
What is interesting to note is that the WPI inflation has been in negative for the last eight months, but CPI is in positive zone, leaving a substantial 7.8 percentage point gap between these two inflation estimates. The divergence was an average of 2.8 per cent in 2014.The dramatic increase in the divergence between the two indices is a matter of concern. It throws light on the genuineness of methodology of WPI and CPI estimation.
Low Inflation and Common Man
From 1969 until 2010, the average inflation rate in India was 7.99 percent reaching an historical high of 34.68 percent in September of 1974 and a record low of -11.31 percent in May of 1976. Inflation was 11.42 in 2008 (13 year high). It dropped to 0.26 per cent in March 2009- a 30 year low. It became negative i.e.-1.61 per cent in June 6, 2009, the phenomenon was called deflation (after 1978). It again increased to 16.22 in Jan, 2010, but decreased to 8.62 percent in June of 2011.WPI headline inflation stood at 7.3 percent and core inflation at 4.3 percent in 2013.
At the end of January 2014, WPI inflation was 5.05 per cent and core inflation 3.0 percent. From December 2014 to July 2015, CPI (retail inflation) has consistently moved upwards, where as the WPI (headline inflation) has dramatically contracted. 2015 is relatively a benign year after three successive years of inflation (see table.2). The CPI was averaged 8 to 9 per cent in every month of these three years. It means that CPI based inflation has not been contained over a sufficient long period of time.
Inflation During 2015
2015Inflation WPI basedInflation CPI basedJan-0.955.2Feb-2.25.4Mar-2.35.3Apr-2.44.9May-2.25.0June-2.45.4July-4.053.69August-4.953.66
Source: RBI, Handbook of Statistics on Indian Economy
It is believed that despite the easing of CPI, food price inflation continued to remain “sticky”. India’s August retail inflation CPI fell to its lowest level in four years to 3.66 per cent while wholesale price index fell the most in history by 4.95 per cent. Rural CPI inflation in August stood at 4.47 per cent compared to 4.44 per cent in July, while in the urban areas it was 2.67 per cent in August compared with 2.94 per cent a month before. . The major worry in the retail inflation is food inflation, although it declined form a high of 13.6 per cent in 2010 to 2.2 per cent in August 2015 as per the CPI data. Onion and pulses turned up costlier in August as compared to July as per WPI data. Food price inflation continues to remain sticky, with cereals and pulses getting pricier compared to previous month. Similarly, if food inflation is high, it would not inflate CPI-based inflation as fast as it does earlier because of the fall in weightage assigned to them. Also the rising gap between food inflation between India’s rural and urban regions indicates to serious pricing mismatches existing in food products. Further, the fear of high food prices and low food grain production is unfounded.
The deficiency in monsoon and the consequent draught expected will lead to increase in food prices in the coming year. The rainfall was 16 per cent below normal in July and 22 per cent below normal in August but still the food prices have actually declined in the July-Aug period. It is calculated that the overall rain deficit for the country as a whole is at 12 per cent as on 23 September 2015 and hence the country could make it a net importer of food grains. The gap between the domestic requirement of food and the estimated harvested crop could jack up the food prices. Further, weakening of Indian rupee will make the import of pulses costlier this fiscal.
Table.1 makes it clear that the falling oil prices will now have less impact on CPI-based inflation because of the low weightage assigned to it. Meanwhile, the WPI is more sensitive to fuel. It assigns a weight of 14.91 per cent to fuel prices. The CPI assigned 9.49 per cent to fuel earlier and now it is 6.84 per cent only. It is still evident that the rise in the fuel and light inflation in August in the retail consumption basket is 5.7 per cent as against 5.4 per cent a month before. In fact, the balance between drop in fuel price and rise in food price will determine inflation in the country.
The above explanation makes it clear that the fall in CPI has not transmitted to common man due to food inflation and less impact of fall in oil prices. There are two studies support this. A survey by the Reserve Bank of India (RBI) in August 2015 showed households expect consumer inflation to hit 10.1 percent within three months, almost double the current 5.4 percent and a level not seen since late 2013.Another survey conducted by The Hindu Business Line among 350 consumers, 68 per cent said they still have not seen benefits of a lower inflation (The Hindu Business Line, 10 August, 2015).According to the study, the spending pattern is largely responsible for this. Expenditure on food accounted for more than 50 per cent of the household budget in a month for 26 per cent of families and spending on fruits and vegetables accounted for more than 10 per cent of monthly expense for 74 per cent of respondents. This pattern is not clear reflections of weightage assigned to these items in CPI estimation and hence common man has not been benefited out of the fall in CPI index.
To conclude, there is no doubt that Indians live in a pleasant economy in terms of official inflation numbers. The reality is that the official numbers are not reflected in retail purchases. The studies conducted by RBI and The Hindu Business Line support this aspect. The coming months will face a price hike in food items due to the monsoon deficiency and consequent chance of fall in domestic production of food grains. The rupee depreciation will aggravate the situation as it becomes costlier to import the goods. In this context the inflation targeting as designed by RBI will not be an easy task. It must be noted that India moved to inflation targeting by setting it at 4 per cent with a band of +/- 2 per cent around it. Earlier this year itself, the RBI and the Government agreed on adopting a target to keep inflation between 2 and 6 per cent. However, the RBI announced that it should bring inflation below 6 per cent by January 2016, and 4 per cent (plus or minus 2 %) in the following years. The present scenario is favourable for this but the effect of monsoon deficiency, weak rupee, and food inflation will not make things easier. Even if the authorities are able to realize this target, whether common man will be benefited out of a low inflation is questioned.
 When all items are taken into account it is called headline inflation
 When food and fuels are excluded it is called core inflation
 When food items alone are taken into account it is called food inflation.
* Author is Chief Economist at CPPR. Views are personel