WPI, CPI and GDp Deflator are 3 ways to measure Inflation. Don't mug-up dates. These are only for clear understanding.
WPI = Wholesale price index
- Compiled by Office of Economic Adviser ->Ministry of Commerce and Industry.
- Base year 2004
- Doesn’t cover services.
- Items are classified into three categories
- Primary articles
- Fuel, power, light, lubricants
- Manufactured products.
Earlier Government used to give weekly primary and food inflation data based on the Wholesale Price Index. But this practice has been discontinued since 2012.
CPI = Consumer price index
- In 2012, the CPI system was reformed
| Before 2012 | After | |
| Subtypes | There were four subtypes of CPI
| Now only three subtypes of CPI
|
| Prepared by |
| All prepared by Central Statistical Organisation (CSO) -> Ministry of Statistics and Programme Implementation |
| Baseyear | Different years for different subtypes.
| Common base year ( 2010) for all three subtypes. |
WPI vs CPI difference?
| WPI | CPI (reformed in 2012) | |
| Compiled by | Economic advisor | CSO |
| Ministry | Commerce ministry | Statistics ministry |
| Includes services? | No | Yes |
| Baseyear | 2004 | 2010 |
| Items included | 676 | 200 |
| Known as Headline inflation? | Yes | no |
| Importance | When RBI and Government make policies, they mainly pay attention to this number. | Not much |
GDP deflator
GDP deflator
- It is calculated by Central Statistical Organisation (CSO)-> Ministry of Statistics and program implementation.
- GDP deflator =GDP @current price divided by GDP @constant price
- GDP deflator is the most comprehensive number to measure inflation, but RBI /Government doesn’t use it much for policy making because GDP deflator data comes quarterly (and not weekly/monthly basis).
How to contain inflation
| By | How? |
| Government | Taxation, Expenditure, export bans etc. |
| RBI | Repo, SLR, CRR |
What Government did to control inflation
Via import
- Govt reduced import duties for wheat, onions, pulses, and crude palmolein were reduced to zero
- Govt. allowed duty-free import of white/raw sugar.
- Govt. imported pulses and edible oils and distributed them at subsidized rate.
Via bans / coercive measures
- Govt. put ban on onion export for short periods of time whenever required
- Govt. suspended futures trading in rice, urad, tur, guar gum and guar seed.
- Govt. banned exports of edible oils (except coconut oil and forest-based oil) and edible oils.
- Govt. imposed stock limits on certain essential commodities such as pulses, edible oil, and edible oilseeds and rice.
- Increased excise duty on gold.
Via schemes
- Govt. has been giving rice and wheat to poor families at very cheap rate under the Antodyaya Anna Yojana.
- Govt. allocated huge amount of foodgrain under the targeted PDS (TPDS).
- government has allocated rice and wheat under the Open Market Sales Scheme (OMSS)
- direct cash transfer.
- Introduced Rajiv Gandhi Equity Saving scheme (with tax benefits) to make people invest money in it, rather than in gold.
Via Policy/Act
- Recently the government permitted FDI in multi-brand retail trading. This will improve logistical facilities connecting farmers with the final consumers and cut down the middlemen.
- The States of Madhya Pradesh and West Bengal have recently waived the market fee on fruits and vegetables. Such waivers are expected to promote investment private sector in the infrastructure necessary for transports and processing of fruits and vegetables.
- Budgetary provisions for improving storage and warehousing facilities, creating infrastructure for aquaculture etc.
Why inflation out of Control ?
- From above points, it seems Government did lot of things to reduce inflation. Then why are we not seeing any good results?
Export bans = uncertainty
- Because, to fight food inflation, govt. started imposing ban on exporting some food commodities, increased and decreased the duties on import/export as necessary.
- While this may look a good solution for the short term but in long term, this creates uncertainty for businessmen, farmers.
- It reduces their incentive to produce more, because they’re not certain whether govt. will allow them to export or not? (for example Sugarcane->sugar, onion etc.)
- So indirectly, this affects employment and income of people => leads to more inflation.
Export bans = CAD
- When Government puts ban on export of xyz item, that means India receives that much less foreign exchange (dollars). So this increases the Current Account deficit (CAD).
- When CAD increases = rupee weakens against dollar = crude oil become expensive for us = inflation in everything.
Therefore, export bans are like firefighting / short term quickfix solutions. They donot solve the fundamental problems of Indian economy, infact they worsen it in long run.
Black money and gold purchase
- All Government schemes = leakage, corruption. And corruption =black money. And black money is mostly invested in gold and real estate.
- So demand of gold forever high= high current account deficit = rupee weakens against dollar= crude oil price increases = petrol/diesel price increases = even more inflation.
- Government did try to hike excise duty, make PAN cards mandatory for high value gold purchase and even thought of putting bans on gold import. But these moves have been heavily opposed by the jeweler lobby, hence Government has shied away from doing anything “radical” to stop the gold consumption.
- Besides a small hike of 2-3% in gold excise duty doesn’t prevent those bad guys with black money from buying gold! And Government hasn’t done much to stop the Black money / corruption either.
FDI and infra= No quick results
- You have read and heard this ten thousand times that FDI in multibrand retail = no middlemen = less inflation in food. And similarly cold storage, and food processing infrastructure= less wastage.
- But, suppose Government allows wallmart on Monday, that doesn’t mean from Tuesday Wallmart will start running and from Wednesday inflation will be gone. All these things take months and years to get file permission, construction, hiring and training employees, setting up supply lines etc.
Environmental clearances
- Many coal and mining projects are not cleared due to environmental issues.
- This has affected the electricity and raw material supply = input cost increased in manufacturing sector=inflation.
Fiscal consolidation
Government is on the path of “fiscal consolidation” so it increased the prices of petrol, diesel and reduced the number of subsidized LPG cylinders. These moves have increased the inflation.
What RBI did to control inflation
Let’s do a recap: from SBI mananger’s point of view
| CRR | I’ve to keep this much cash aside. I cannot loan it to people. I donot earn any interest on this. |
| SLR | I’ve to invest this much cash in govt. securities, gold and reliable corporate bonds. |
| Repo | I’ve to pay this much interest rate, IF I take short term loans from RBI. |
| Reverse Repo | I earn this much interest rate, IF I deposit my money in RBI for short term. |
So what will be the impact on liquidity when RBI changes these rates?
| Rate | When rate is increased | When rate is decreased |
| CRR | Liquidity decreases | Liquidity increases |
| SLR | Liquidity decreases | Liquidity increases |
| Repo Rate | Liquidity decreases | Liquidity increases |
- Note: RBI doesn’t need to change reverse repo rate, because they automatically keep it 1% less than repo rate. (1%= 100 basis points).
- In winter, the supply of green vegetables is high so their price goes down. But in summer, their supply is low, so price goes high. Same is the link between liquidity and interest rates.
- When liquidity increases = loan interest rate decreases.
- When liquidity decreases = loan interest rate increases = harder to get loans for home, car, bike, business.
RBI focused its monetary policy on two objectives
- Control inflation.
- Facilitate growth.
- But It has been very difficult to do both these things at the same time. Because if RBI wants to control inflation, then it needed to reduce the liquidity= RBI had to increase repo rate, CRR. But this type of tight” monetary policy badly affects both producers (businessmen) and consumers. Why?
- But when repo rate is increased= liquidity decreased= difficult to get loans for home, car, bike etc.= demand down + difficult for businessmen to get loans = this hurts the businessman and whatever hurts the businessmen – also hurt the GDP and employment.
To put this in refined words: the tight monetary policy of RBI decreased the flow of
credit (loan) to productive sectors of Economy and hence negatively affected the growth.
- But due to inflationary pressures, RBI followed tight monetary policy during 2010-11.
- During this period, RBI raised policy rate (repo rate) by 3.75%= repo rate was increased from 4.75 per cent to 8.5 per cent. Check the following chart.
- But this move has backfired: global economy was progressing slow (due to problems in EU, and USA not yet fully recovered) => so, this tight monetary policy actually contributed to a sharper slowdown of Indian economy than anticipated.
- GDP growth rate fell down from good 9+% to around 5-6%.
Why RBI failed to control inflation?
- We’re facing inflation because there is mismatch between supply and demand.
- Supply (of food, gold, houses, everything) is low
- While demand of those items (particularly food) is high (because population is high, the income levels of public has increased).
- Now think about this: What can RBI do? It can only increase the interest rates.
- While increased interest rates may decrease the demand of houses, cars, bikes but it cannot directly decrease the demand of food, milk and other essential commodities.
- In other words, Interest rates cannot change the dietary habits of people, not at least in the short term.
- Besides, high interest rates make it difficult for businessmen to borrow = less new projects = less new employment, less GDP.
- Therefore primary solution to fight India’s inflation =Increase the supply of food items.
- But this will requie thorough revision of the way govt. treats agriculture, allied activities, food processing and infrastructure. Small farms, disguised unemployment, heavy reliance on monsoon : all these issues must be addressed in comprehensive manner.
What is RESIDEX ?
- Rural to urban migration is an inevitable part of economic growth.
- But when people migrate from rural areas to urban areas, it creates pressure on civic amenities and housing (slums).
| Year | % of Indian population living in Urban areas |
| 1951 | 17 |
| 2011 | 30 |
| 2040 | 50 (expected) |
- Until recently, we did not have an index to capture the prices of residential buildings in urban areas.
- Hence “Residex” index was launched in 2007.
- This index records the changes in the prices of residential buildings.
- According to the RESIDEX, the housing prices have declined in Hyderabad, Banglore and Jaipur (from 2007 to 2012) but they have increased by more than 100% in Pune, Bhopal and Chennai.
Also for better understanding of Economy click Very important basics of CRR, SLR, Rates
