Inflation is not only a factor which is tracked by Fixed Income Group or traders but by every part of financial markets. It was a bit confusing for me to make inferences on complex terminologies used to calculate inflation. But yes, now I think it’s not at all confusing. Let’s try and decode parameters related to inflation.
What is Inflation
Inflation is a general increase in prices of respective objects for a specified period. Here objects can be food, fuel, commodities, etc. Normally inflation is calculated on a Y-o-Y basis.
Types of Inflation (On Calculation basis)
What I read in number of articles compels me to say that in principle there are four main types of Inflation.
- WPI (Wholesale Price Index)
- GDP Deflator
- PRIVATE FINAL CONSUMPTION EXPENDITURE
- CPI (Consumer Price Index)
- CPI for industrial workers (CPI-IW)
- CPI for Agricultural Labourers (AL)
- CPI for Rural Labour (CPI-RL)
- CPI for urban non-manual employees (UNME)
WPI (Wholesale Price Index):
The Wholesale Price Index (WPI) is used extensively as a measure of inflation and important monetary and fiscal policy changes are often linked to it. The WPI indices are also used for the purpose of escalation clauses in the supply of raw materials, machinery and construction work.
The WPI in its role as a guide to policy formulation has several critical limitations. The important limitations relate to
(a) Non-inclusion of services (which is ~58% of our GDP)
(b) Following a fixed weighting scheme while the economy is undergoing major structural changes
(c) Use of gross transactions data rather than data on final purchases. (Considered Wholesale price rather than Consumer end prices)
WPI numbers are published here at fortnightly lag (i.e. July numbers are published on ~14th Aug). WPI covers 676 commodities. Below is the Composition and weights:
|Fuel and Power||14.91|
^ approx 15% is of food articles :: #approx. 12% is of food products.
GDP Deflator, on the other hand, is a comprehensive measure, statistically derived from national accounts data released by the Central Statistical Organisation (CSO) as a ratio of GDP at current prices to GDP at constant prices. Since it encompasses the entire spectrum of economic activities including services, the scope and coverage of national income deflator is wider than any other measure. Earlier, GDP Deflator was available only annually with a long lag of over one year and hence had very limited use for the conduct of policy. That has changed recently and the GDP Deflator is now available quarterly.
The WPI is compiled only for commodity producing sectors and does not include services sector, whereas GDP deflator cover all the economic activities of the country, including services.
CPI (Consumer Price Index):
CPIs are meant to reflect the cost of living conditions for a homogeneous group of consumers based on retail prices. Among the four measures of CPI, the CPI for Industrial workers (IW) has a broader coverage than the others – the CPI for agricultural labourers (AL), rural labourers (RL) and urban non-manual employees (UNME). In the organised sector, CPI-IW is used as a cost of living index. Also when we hear CPI is 10.02% that by default signifies CPI (IW) figure.
At the retail level, CPI is meant to reflect the cost of living conditions and is computed on the basis of the changes in the level of retail prices of selected goods and services on which consumers spend the major part of their income. Therefore, a broad based CPI for the country as a whole, including both services and manufacturing products, has greater relevance for monetary policy formulation. RBI also has favoured CPI over WPI.
CPI numbers are published here at a 3 Week Lag (i.e. July numbers are published on ~21th Aug). Below is the Composition and weights for CPI (IW):
|Pan, Supari, Tobacco & Intoxicants||3.15|
|Fuel and light||6.28|
|Clothing, bedding and footwear||8.54|
* Miscellaneous group consists of medical care, education, transport and communications, recreation and amusement, personal care and effects, laundry, domestic services, etc
PRIVATE FINAL CONSUMPTION EXPENDITURE DEFLATOR
India has four retail measures of inflation – consumer price index (CPI) for industrial workers, urban non-manual employees, agricultural labour and rural labour – but none of these is a comprehensive index. Each of these is a targeted index for a particular consumption group with a very specific product basket. In the case of agricultural labourers, for instance, the index has a high weightage for food items. For this reason, none of these can be taken as a composite measure of retail inflation. In such a situation, the deflator for private final consumption expenditure (PFCE) becomes the most important measure of retail prices. Of course, PFCE deflator also has its shortcomings in that it is available only quarterly and that too with a two month lag, which makes it almost useless for monetary policy purpose. Nonetheless, to the extent it is a comprehensive measure that includes both goods and services a trend line for the retail inflation so derived kind of validates the other retail indices. It is a hardly discussed parameter.
Major Difference between GDP Deflator CPI and WPI
The main difference is that the GDP deflator reflects the prices of all goods and services produced domestically, whereas other price indices reflect the prices of all goods and services bought by average consumers, either at retail or wholesale markets. For example, suppose that the price of defence materials produced by an Indian company in India rises. Even though these materials are part of GDP, they are not part of the basket of goods and services bought by a typical consumer. On the other hand, imported consumption goods are not part of GDP but sometimes form part of the basket of goods of common consumer. Therefore, rise in imported consumer goods will affect consumer price index but not the GDP deflator. This difference has important implications particularly for oil price changes. When price of oil rises, consumer price index rises much more than does the GDP deflator. When it comes to CPI, it is more skewed towards food articles making ~57% of total weightage whereas WPI has only ~27% food weightage (see above)
What I think is WPI, CPI and GDP Inflator are considered by analyst in some or other way to evaluate and contemplate future stance on an economy.
Source : Mospi, indiabudget.nic.in, rbi.org.in, News paper Articles
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