12 Mar

Price Indices & Inflation

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Contents

1. Consumer Price Index
2. CPI Industrial Worker (CPI-IW)
3. CPI for Rural Laborers and Agricultural Laborers (CPI-AL)
4. Wholesale Price Index (WPI)
   A) why the methods of CPI/WPI calculation needs to change regularly
5. Difference between CPI, WPI and GDP Deflator
6. Difference between Wholesale Prices and Retail Prices inflations
7. Other Basic Terms to Understand
8. Factors Affecting Inflation
9. Housing Sector Prices
10. Pharmaceutical Prices (Control Efforts)
11. Efforts to Control Inflation
12. Different

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• A price index measures the average change in prices of a basket of goods and services with respect to a base year.
  • Any Price Index (CPI or WPI) is calculated by measuring the rise in price of current year with respect to base year.
  • Price Index = (Weighted Price for current Year / Weighted Price for base year) * 100
• Inflation is defined as an upward movement in the general prices of goods and services and is estimated as the percentage rate of change in a price index over the reference time period.
  ▫ It can be measured on the basis of Consumer Price Index or Wholesale Price Index.
  ▫ Inflation = [(Current Period Price Index – Last Period Price Index) / Last Period Price Index] * 100
• Note: Base year is only used for calculation of index and not for the calculation of inflation.
• Weight in CPI is decided on the basis of expenditure surveys conducted by NSSO.

Various Indices Calculated in India	Calculating Authority
CPI- Combined (CPI-C)	CSO
CPI-Urban	CSO
CPI-Rural	CSO
Wholesale Price Index (WPI)	Office of Economic Advisor, Ministry of Commerce and Industry
Consumer Price Index for Industrial Worker (CPI-IW)	Labor Bureau, Shimla, Ministry of Labor
Consumer Price Index for Urban Non-Manual Employees (CPI-UNME)	CSO (it WAS discontinued in 2012
Consumer Price Index for Agricultural Laborers (CPI-AL)	Labor Bureau, Shimla, Ministry of Labor
Consumer Price Index for Rural Laborers (CPI-RL)	Labor Bureau, Shimla, Ministry of Labor

• Note: CPI-AL/RL is used for determining the minimum wages and those for the government’s rural jobs under the MGNREGA.
• Note: CPI-AL is a subset of CPI-RL and is used for revising minimum wages of agricultural laborers.
• Note: CPI-IW is used for wage indexation in organized sector and government jobs.

– Core Inflation:

• Core inflation is the change in the costs of goods and services but doesn’t include those from food and energy sector. These items are excluded as they are very volatile and temporary/seasonal.
• Core inflation is studied to understand the long-term trend of price rise which can help in better framing of long-term policies.

1) CONSUMER PRICE INDEX (CPI)

• Consumer Price Index measures the average change of prices paid by the final consumer for a basket of goods and services.
  • CPI = (Weighted Price for Current Year / Weighted Price for base year) * 100
• CPI (Rural, Urban and Combined) are three new all India indices.
  ▫ The indices such as CPI-AL/RL or CPI-IW only covered a segment of population and didn’t give complete countrywide picture.
  ▫ CPI (Rural, Urban and Combined) cover all segments of population and gives a general idea about the price rise in the country.
  ▫ These are published at all India as well as state wise levels.
• In Feb 2015, Central Statistical Organization (CSO), Ministry of Statistics and Programme Implementation has made some changes in the method of calculation of CPI.
  i. Base Year: Base year has been changed from 2010 = 100 to 2012 = 100.
  ii. The Basket of Items and their weights
  • The basket of items and their weight diagrams have been prepared using the Modified Mixed Reference Period (MMRP) data of Consumer Expenditure Survey (CES), 2011-12, of the 68th Round of National Sample Survey (NSS).
  • Earlier, the weighing diagrams of old series of CPI were based on the Uniform Reference Period (URP) data of CES, 2004-05, of the 61st round of NSS.
  • Benefits
    • The new method is more consistent with the international practice of shorter reference period for most of the food items and longer reference period for the items of infrequent consumption/purchase.
    • The gap between weighing reference year and price reference year (Base Year), which was six years in the old series, has now been reduced to six months only.

iii. Increase in number of groups.

• • Earlier, number of groups were 5.
  • Now, they have increased to 6.
    • Pan, tobacco and intoxicants, which was a subgroup under the Group ‘Food, beverages and Tobacco’, has now been made as a separate group.

S No.	Subgroup	Description	Weight Rural	Weight- Urban	Weight- Combined
1	Food and Beverage		54.18	36.29	45.86
2	Pan, tobacco and intoxicants		3.26	1.36	2.38
3	Clothing and footwear		7.36	5.57	6.53
4	Housing			21.67	10.07
5	Fuel and Light		7.94	5.58	6.84
6	Miscellaneous	Household goods and services, health, transport and communication, recreation, education, personal care and effects	27.26	29.53	28.32

iv. Increase in number of items in the basket.

• •  437 to 448 (Rural)
  • 450 to 460 (Urban)

v. The weight of the Core group (CPI ex-food and fuel) increased.

• • From 42.9% to 47.3%

2) CPI INDUSTRIAL WORKER (CPI-IW)

• CPI-IW is a price index released by Labour Bureau to measure the impact of price rise on cost of living for working class families spread across certain select industries. It is disseminated on monthly basis.
• Significance
  ▫ Guide for policy formulations
  ▫ Fixing/revising wages
  ▫ Regulation of dearness allowances (DA) paid to large number of manual workers and Central/State government employees.
• Revision of base year from 2001 to 2016 (Oct 2020)
  • Why? To capture the latest consumption pattern.
    • FROM CPI-IW Series 2001 = 100 to a more recent base year 2016 = 100.
  • The new Series of CPI-IW covers the industrial workers from existing seven sectors viz. Factories, Mines, Plantation, Public Motor Transport Undertaking, Electricity Generating & Distribution Establishments and Ports & Docks.
  • The new series has a wider coverage in terms of sample size, number of centres, markets/outlets, items etc.
  • As recommended by Technical Advisory Committee on Statistics of Prices and Cost of Living (TAC on SPCL), Labour Bureau has revised the classification of items in CPI-IW into different Groups and Sub-Groups in line with NSO’s Classification of Individual Consumption by Purpose
    (COICOP). The revised six groups based on the COICOP classification and their respective weights for different series are as follows:

3) CPI FOR RURAL LABORERS AND AGRICULTURAL LABORERS (CPI-AL)

• It measures the changes in price of commodity basket consumed by rural laborers like agri laborers, laborers of village and cottage industries etc.
  ▫ Consumer Price Index for Agricultural Laborers (CPI-AL) is a subject of CPI for Rural Laborers. It is used for revising minimum wages for agricultural laborers in different states.
• Authority: Labour Bureau, Shimla, Ministry of Labour.

4) WHOLESALE PRICE INDEX (WPI)

• The index measures the change in the price of commodities supplied to wholesale market. It is based on the value of production adjusted for net imports.
  ▫ For e.g., price of mineral at ex-mines, price of manufactured products at ex factory, price of agri products at mandi price are considered for the calculation of WPI.
• Some features
  ▫ Captures inflation closest to producers and has a broader coverage of manufactured goods.
  ▫ Doesn’t capture price inflation in services.
  ▫ It is measured year on year basis i.e., rate of change in present level in a given month vis a vis corresponding month of last year. This is also known as point-to-point inflation.
  ▫ Indirect taxes are excluded from the price.
• Authority responsible for compilation and release
  • Office of the Economic Advisor, DPIIT, Ministry of Commerce and Industry.
• Base Year: 2011-12 = 100.
• Recent Changes in WPI calculations (May 2017)
  1. Change in base year: 2004-05 => 2011-12
     • More recent base year is more in keeping with international best practices and also provide more representative and accurate data.
  2. Updating the weight basket and weighting structure conforming to the structure of economy in 2011-12
     • Number of items: Increased to 697 from earlier 676.
     • Increase in weight of primary items.
       • From 20.1% to 22.6 percent
     • Decrease in the weight of fuel and power.
       • From 14.9% to 13.1%.
     • Decrease in weight of manufacturing items.
       • From 64.9 percent to 64.2 percent.
         Table showing new commodity group and their weights in WPI.

S. No	Commodity Groups	Weight	No of Articles
1	Primary Products	22.6%	117
2	Fuel, Power, Light & Lubricants	13.1%	16
3	Manufactured Products	64.2%	564

3. Doesn’t include Indirect taxes.

• In the new series of WPI, prices used for compilation do not include indirect taxes in order to remove impact of fiscal policy. This is in consonance with international
  standards and will make the WPI conceptually closer to Purchasing Price Index

4. A new WPI food Index is compiled to capture the rate of inflation in food items.

5. Seasonality of fruits and vegetables has been updated to account for more months as these are now available for longer duration.

6. Item level aggregate for new WPI is compiled using geometric mean (GM) following international best practices and as is currently used for compilation of all India CPI.

7. A High-level technical review committee

• • Government has also set up a high-level technical review committee for dynamic review in order to keep pace with the changing structure of the economy

A) WHY THE METHODS OF CPI/WPI CALCULATION NEEDS TO CHANGE REGULARLY

• The changes are aimed at capturing the structural changes in the economy and improving the quality, coverage and representativeness of the indices.
• The new methods are more in consonance with international standards and hence international comparison also becomes easier.
• Changes GDP numbers
• WPI is used as deflator for many sectors of the economy for estimating real GDP and the earlier GDP estimates were based on inflation calculated on 2004-05 base.
• Technical review committee will ensure that the changes in the economy are captured more frequently, and you do not wait for next revision of the base year.

5) DIFFERENCE BETWEEN CPI, WPI AND GDP DEFLATOR

• CPI measures prices at consumer level and WPI does it at whole sale level.
• CPI includes services, WPI doesn’t
• CPI includes impact of indirect taxes, WPI doesn’t
• WPI also includes capital goods (goods not directly consumed by consumers), CPI doesn’t
• Both CPI and WPI take into consideration the imported goods but GDP deflator only takes into consideration the domestically produced goods and services.
• Note: GDP deflator is released by CSO

6) DIFFERENCE BETWEEN WHOLESALE PRICES AND RETAIL PRICES INFLATIONS

• Why retail inflation becomes higher than whole sale inflation?
  ▫ High Transaction cost
  ▫ Weak infrastructure system
  ▫ Weak information system
  ▫ Poor marketing facilities
  ▫ Huge margin of middlemen
  ▫ Collusion among traders -> Poor competition
  ▫ Asymmetry in the transmission of price signals from wholesale to retail prices and vice versa

7) OTHER BASIC TERMS TO UNDERSTAND

• Deflation -> Opposite to inflation (fall in prices i.e. rate of change in price index is negative)
• Reflation -> deliberate action of government to increase the rate of inflation. Done to redeem the economy from deflationary situations
• Disinflation -> decreasing rate of inflation (but inflation is still positive)
  • E.g. inflation last month 6%, this month 5% -> it is termed as disinflation.
• Phillips Curve
• Stagflation
  ▫ Situation of co-existence of stagnation and inflation in the economy. Stagnation means low National Income growth and high unemployment.

8) FACTORS AFFECTING INFLATION

• Increase in Demand of a product/service.
  ▫ More money with people -> cheap loans (i.e., cheap monetary policy), increased disposable income etc.
  ▫ Fiscal Stimulus by government i.e., increase in government expenditure
  ▫ Repayment of public debt by government
• Decrease in Supply
  ▫ Natural disasters, calamities
  ▫ Lack of production (e.g., pulses)
  ▫ Industrial disputes
  ▫ Hoarding
  ▫ Trade War -> high duties, restriction on imports etc.

WHO BENEFITS FROM HIGH INFLATION

Debtor, producer, Groups whose income is linked to inflation (flexible income groups); Equity Holders

A) WHO SUFFERS FROM HIGH INFLATION

• Creditors, Consumers, Fixed income groups, Equity holders (monetary tightening may reduce the money supply and hence stock prices), debentures or bond holders.

B) OTHER IMPACTS OF HIGH INFLATION

• Depreciation of Rupee
• Imports become expensive (BoP issues) etc.

C) FACTORS WHICH CONTRIBUTE TOWARDS INFLATION CONTROL

• Resilient Fiscal and Monetary Policy Framework
• Structural Reforms of labor and product markets that strengthen competition.
• Adoption of Monetary Policy Framework for fiscal targeting
  ▫ According to World Bank, there are 24 emerging market and developed economies which have introduced monetary policy framework for inflation targeting, since the late 1990s.

D) INFLATION AND BASE EFFECT

• When changes in the CPI in the base month have a considerable impact on changes in YoY inflation, this is referred to as base effect.
  • Base effects are therefore the contribution to changes in the annual rate of measured inflation from abnormal changes in the CPI in the base period.

E) COBWEB PHENOMENON

• Cobweb theory is the idea that price fluctuations can lead to fluctuations in supply which cause a cycle of rising and falling prices.
  • The farmers are caught in the cobweb phenomenon when they base their sowing decisions on prices witnessed in the previous marketing period.

• • So, if the farmer observes a higher price for a specific crop in period ‘t-1’, he would opt to produce more of it in period ‘t’. However, if the production of the crop exceeds market demand, prices fall in period ‘t’, signaling farmers to produce les of the commodity in period ‘t+1’.

9) HOUSING SECTOR PRICES

• ESI 2022-23:
  ▫ The National Housing Bank (NHB) publishes two housing price indices with FY18 as the base year.
  ▫ HPI Assessment Price
  ▫ HPI Market Price Quarterly
• HPI Assessment Price is based on the valuation of prices of residential units collected form primary lending institutions.
• HPI Market Price is based on the market prices for unsold inventories collected from developers.
• A composite index is calculated for 50 cities across India using the population of the cities as weight.
• HPI Market price have shown a general increasing trend in
  most cities.
• COVID-19 crisis had significantly impacted the residential real estate market. The real estate industry started gaining momentum from Sep 2020 on wards and peaked at the end of March 2021. But, the second wave again impacted it. However, timely policy intervention by the government coupled with low home loan interest rates propped up demand and attracted buyers more readily in the affordable segment in FY23.
• The overall increase in composite HPI assessment and HPI market prices indicate a revival in the housing finance sector. A stable to moderate increase in HPI also offers confidence to homeowners and home loan financiers in terms of the retained value of the asset.

10) PHARMACEUTICAL PRICES (CONTROL EFFORTS)

a. National Pharmaceutical Pricing Policy, 2012

• The principles for the regulation of the prices of drugs are based on the National Pharmaceuticals Pricing Policy, 2012, administered by the Department of Pharmaceuticals. The key principles of the policy are the essentiality of drugs, control of formulation prices and market-based pricing.
• NLEM 2022 was promulgated by Ministry of Health and Family Welfare in September 2022 and revised Schedule I of Drugs (Prices Control) Order (DPCO) was notified on 11 November 2022 by Department of Pharmaceuticals incorporating NLEM, 2022. Ceiling prices of 119 formulations under NLEM, 2022 have been fixed until 31 December 2022. In addition, retail prices for 2,196 formulations have been fixed under the DPCO, 2013.

b. Jan Aushadhi Scheme (Now known as Pradhan Mantri Jan Aushadhi Yojna (PMJAY))

11) EFFORTS TO CONTROL INFLATION

• Monetary and Fiscal Policy measures
• Advisories to state governments for strict action against hoarding & black marketing and effectively enforce the Essential Commodities Act, 1955 & the Prevention of Black-Marketing and Maintenance of Supplies of Essential Commodities Act, 1980 for commodities in short supply.
• Higher MSPs to incentivize production of food items in short supply.
• Prize Stabilization Fund Scheme (PSF) is being implemented to control price volatility of agri commodities like Potato, Onion, pulses etc.
• Enhancement of buffer stocks of pulses
• Export duties on export of certain food items.
• Essential Commodities Act

12) DIFFERENT

• Creeping ( < 3%), Walking or Trotting (3-7% to less than 10%), Running (10-20%),
  Hyper/Runaway/Galloping (20 – 100% 0r more)