CPI to be most realistic inflation index

To better reflect how a consumer is affected by inflation and also to incorporate the components missing in the wholesale price index (WPI), the government recently came out with the consumer price index, which for the first time took an account of prices at the retail level to prepare the index.

The index, which is expected to use a defined basket of goods and services that is driven from the consumption side to provide a relatively realistic view on how consumers are affected by inflation, is considered to gauge prices better than the WPI.

It is also expected to provide a comprehensive reference point to policymakers by covering retail prices in five major food groups, fuel, clothing, housing and services across rural and urban India.

This was completely missing in the WPI as more than 100 out of 435 commodities included in the index have ceased to be important from the consumption point of view. Hence, it was needed to switch to a more steady CPI, economy watchers say. Besides, the WPI measures general level of price changes either at level of wholesaler or at the producer and does not take into account the retail margins.

Moreover the inflation figures that we continued to get every Thursday until recently did not make any difference to consumers, as most of the commodities on which inflation were calculated did not form part of individual consumers budget.

Therefore a shift was required to CPI, said Mahesh C Purohit, Director of Foundation for Public Economics and Policy Research. “This will make it easier to know what exactly is affecting your budget in terms of price rise, because it is prepared taking ones on account the consumption pattern,” he said.

CPI is a better indicator of demand side pressure, he said. To some economists, CPI is a cost of living index. Besides, in the present day, service sector plays a key role in Indian economy. Consumer spending on services like education and health has been increasing manifold. These services are not incorporated in calculation of WPI.

“This is major component missing in WPI,” Purohit said. What is WPI and how its so vastly different from CPI?  Well, WPI is the index used to measure the change in the average price level of goods traded in wholesale market and therefore, does not reflect the retail prices and the real consumer spending behaviour.

Developed economies

Since, the WPI is the oldest and the only index prepared by the Indian government until recently, it is widely used by the policymakers here. WPI was first published in 1902. Most of the developed economies like US, UK, Japan, France, Singapore and even neighbouring China use CPI as its official barometer to weigh its inflation.

While, most developed countries shifted to CPI in the 1970s, India stuck to it till date to rate inflation in the economy. But, the analysts say the weekly data on WPI-based inflation does not adequately capture the movement of prices of manufactured goods, prompting the government to often revise the figures later.
The CPI, they argue, is a more accurate measure of inflation compared with the WPI as it looks into prices of items for consumption rather than manufacturing products. Hence, it can give a fairer picture on how much more you are paying.

India now has three consumer indices CPI for industrial workers (IW), for agricultural labourers (AL) and rural labourers (RL) to reflect price increases for three different segments. This makes it difficult for the Indian government to adopt CPI in calculating inflation. Analysts are of the view that the number of indices makes it difficult for Indian policymakers to calculate inflation based on CPI figures.

Then, there is too much of a lag in reporting of CPI numbers. India calculates inflation on weekly basis, whereas CPI figures are available on monthly basis. Thus, the economists are sure that it would take lot of time for Indian government to eventually have one CPI index incorporating all indices. Most central banks in the world use CPI-based inflation for the purpose of their monetary policy framework.

It is also used in many countries as the measure for indexing public sector wages and pensions and as the standard benchmark for wage negotiations in the private sector.

But, the Reserve Bank of India has been using WPI-based inflation to take monetary policy decisions because of the absence of a comprehensive consumer price index.
“Given a choice, even Indian policymakers would want to shift to the wide and comprehensive index as it better reflects the demand-side pressures, an important ingredient in making policy to tackle inflation,” said an economist from HDFC bank.

The RBI governor D Subbarao too had recently said that the central bank has opted for WPI over CPI as a second-best choice. Although the CPI is the most representative of the price situation in the country, experts expect RBI will not abandon WPI as the primary inflation source anytime soon.

Data collection

They opine that CPI-based inflation data will continue to provide additional inputs to monetary policy making. “RBI will wait for the index to stabilise before starting to target it,” said D K Joshi, chief economist at rating agency Crisil Ltd.

“CPI has the potential to become an important tool for policy making. A lot will depend on the robustness of data collection,” Joshi recently said.

The first nationwide CPI index, which was released last month with January figures, took calendar 2010 as the base year. The data for the new index was collected from 310 towns and 1,181 villages, according to official statement. Both, the National Sample Survey Organisation and the postal department were roped in t o collect data from urban and rural centres respectively.

Softening of prices

The new CPI index showed that inflation came in at 7.65 per cent for January. As expected, consumer price inflation is higher in urban areas, with year-on-year increase of 7.38 per cent in rural areas and 8.25 per cent for urban centres.

The inflation data, based on CPI will be released every month starting January, a move which is expected to make more meaningful in addressing the demand-driven price pressure. The WPI largely reflected the price pressure experienced by producers, which scarcely takes into account the rise or softening of prices at the retail level.

Last but not the least, the new index is also said to help the government in calculating the dearness allowance of its employees as the price increases and its effect on them will be reflected clearly through this. After the implementation of sixth pay commission report, decks were cleared for the calculation of dearness allowance based on CPI index.

The government announces the All India Consumer Price Index every year depending on the existing prices of commodities. For instance the All India Consumer Price Index for Industrial Workers for October 2009 on base 2001=100 had increased by two points and went up to 165. Keeping in view the situation, the Government announced dearness allowance to cope up with the price rise.

“Dearness allowance is an important component of an employees salary in the inflation trend and it will be easier for the government to calculate the same once it shifts to CPI,” Purohit said.

The dearness allowance calculation based on CPI gets another boost with the revised version of the proposed Direct Tax Code recommending indexation of tax slabs to consumer price indices to adjust for inflation.