A flawed calculation of inflation

Synopsis: The current official inflation rate does not correctly measure price rise and it needs modification.

Introduction

Inflation for the last four months has been worryingly high. Wholesale price index (WPI) has been above 10% and consumer price index (CPI) crossed the 6% mark.

Does the official data capture the real picture?

Data issues: Unlock had gradually started in June and July 2020, but normalcy had not returned. Hence, the official inflation figures for these months in 2021 do not reflect the true picture.

The price rise differs for different items of consumption: For WPI, the weights in production are used, for CPI, the consumption basket is used. The consumption basket is vastly different for the poor, the middle classes, and the rich. Hence, the CPI is different for each of these classes and a composite index requires averaging the baskets.

Consumer confidence: RBI data show that consumer confidence fell drastically from 105 in January 2020 to 55.5 by January 2021. That means, even when the economy started to grow officially, consumer confidence had not recovered.

Employment and incomes: they are still down and 230 million slipped below the poverty line. All this implies that the consumption basket for different sections of the population had changed.

Under-representation of services: services are about 55% of the GDP but have no representation in WPI and about 40% in CPI. For instance, health costs shot up during the pandemic, this is not captured in inflation figures.

Why inflation is a cause of worry?

Inflation affects the consumer: If the rate of inflation is 10%, then compared to the previous year a person has to spend 10% more to buy the same number of things.

Impact on the poor: the poor have to curtail essential consumption. In India, 94% work in the unorganised sector and mostly earn low incomes and have little savings.

Impacts on govt’s revenues and the budgetary deficit: inflation puts pressure on the government to cut back budgetary expenditures, especially on the social sector. That aggravates poverty and reduces demand further.

What are the factors contributing to inflation?

Increased taxation of energy to raise resources: Since energy is used for all production, prices of all goods and services tend to rise and push up the rate of inflation. This is an indirect tax, it is regressive and impacts the poor disproportionately more. It also makes the RBI’s task of controlling inflation difficult.

Disrupted supplies: it added to shortages and price rise. Prices of medicines and medical equipment and items of day-to-day consumption also rose. Fruits and vegetable prices collapsed in rural areas but rose sharply in urban areas.

Big business raised prices: in spite of a lower wage bill, they raised prices as reflected in a sharp rise in the profits of the corporate sector.

International factors: Most major economies have recovered and demand for inputs has increased while supplies have remained disrupted (like chips for automobiles). So, commodity and input prices have risen. Also, the weakening of the rupee added to inflation.

Source: This post is based on the article “A flawed calculation of inflation” published in The hindu on 23rd September 2021.