[Eco – 103] Part 2/3 – Inflation – Understanding WPI/CPI/PPI and more.

Hi There ,

As you know Economy as a subject has always been a traditional bottleneck for Civil Services aspirants. This is because most of us did not study it during our school days.

So in this series of articles, we will be taking up the numerous economic jargon, one by one and try to simplify them for you.

We aim to do the above by explaining various economic terms in a simple and a lucid manner. This will be especially beneficial for the students who are going to give their first attempt.

This is the 2nd article in the 3 part series on Inflation. In the previous article we had understood the concept of Inflation 

If you haven’t read the part-1 of the Inflation series then Click Here

In this article we will understand how inflation is measured in India and what are the different types of Indexes used to measure inflation viz:

1. Wholesale Price Index (WPI)
2. Consumer Price Index (CPI)
3. Producers Price Index (PPI)

So let’s begin

What is a Price Index

As we have learned in the previous article – Inflation is sustained increase in price of basket of goods and services over a period of time.

Economists measure the price level with a price index. A price index is a number whose movement reflects movement in the average level of prices. If a price index rises 10%, it means the average level of prices has risen 10%.

The price index is an indicator of the average price movement over a period of time of a fixed basket of goods and services. 

The constitution of the basket of goods services is done keeping into consideration whether changes are to be measured in retail, wholesale or producer price etc. 

The basket will also vary for economy wide, regional or sector specific series. 

At present, separate series of index numbers are compiled to capture the price movements at retail and wholesale level in India. 

Some of the important indices like Wholesale Price Index (WPI), Consumer Price Index (CPI), etc. give a fairly good idea as to what is happening in the economy. 

Among the price indices in India, 

• WPI is compiled and released on monthly basis by the Office of Economic Adviser, Department for promotion of industry and internal trade, Ministry of Commerce & Industry; 
• CPI (Urban, Rural and All India) is released by National Statistics Office (NSO), Ministry of Statistics & Programme Implementation (MoSPI)
• CPI (Industrial Workers), CPI (Agricultural Labour) and CPI (Rural Labour) are a set of Indices released by the Labour Bureau, Ministry of Labour. 

Now First we shall look into WPI.

Wholesale Price Index (WPI)

The WPI is average change of prices of a fixed basket of goods  at the first point of bulk sale in the domestic market over a given period of time

Features of WPI

• WPI measures the inflation at wholesale level.
• The present base year of WPI is 2011-12
• Nodal Office for Compilation and release of WPI is the Office of Economic Adviser, Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry.
• WPI figures are published on a monthly basis.

Base revision in May 2017

The Base Year for WPI was changed from 2004-05 to 2011-12 in May 2017.

Some of the important new features of WPI with Base 2011-12 are

1. The number of items in the basket has been increased from 676 to 697.
2. Number of quotation has been enhanced from 5842 to 8331 to ensure comprehensive coverage and representativeness
3. New definition of wholesale price index does not include taxes in order to remove the impact of fiscal policy. This also brings new WPI series closer to the Producer Price Index and is in consonance with the global practices.  
4. The item level indices are being compiled based on statistically robust Geometric mean as compared to Arithmetic mean used in the WPI 2004-05 series. 
5. As a part of the revised WPI series, a separate WPI Food Index has been launched. WPI food index measures the changes in prices of food items at the level of producers. WPI Food Index along with CPI Food Price Index would help monitor the food inflation effectively in India.

Components of WPI

The WPI comprises of three major groups:

1. Primary Articles (eg- Food Articles, Vegetables, Milk, Minerals etc)
2. Fuel and Power (eg- LPG, Petrol etc)
3. Manufactured Products (eg- manufacture of food products, sugar, manufacture of textiles etc)

The weights of the three major group of items in WPI are shown Below

Thus we can say that in WPI the weightage in decreasing order looks like  

Manufactured Product >> Primary Article >> Fuel & Power

The three major component can further be divided into: (The figure shows major items in WPI along with their weights)

Why do we calculate WPI? What is it’s use?

1. It provides estimates of inflation at the wholesale transactions level for the economy as a whole. This helps in timely intervention by the Government to check inflation, in particular inflation in essential commodities, before the price increase spills over to retail prices.  
2. WPI is used as a deflator for many sectors of the economy for estimating GDP by CSO. It is also used to deflate nominal values of production in high frequency IIP  
3. WPI is also used for indexation by users in business contracts.
4. Global investors also track WPI as one of the key macro indicators for their investment decisions
5. The WPI based inflation estimates also serve as an important determinant, in formulation of trade, fiscal and other economic policies by the Government.
6. WPI is also used for the purpose of escalation clauses in the supply of raw materials, machinery and construction work. Business firms in search of effective methods for coping with changes in prices often employ price adjustment (escalation) clauses in long-term sales and purchase contracts.

WPI Food Index (Weight – 24.38)

As a part of the revised WPI series (base year 2011-12), a separate WPI Food Index has been launched. WPI food index measures the changes in prices of food items at the level of producers. 

The WPI Food index is compiled by taking the aggregate of WPI for Food Products under Manufacture Products and Food Articles under Primary Article using weighted arithmetic mean. 

1. Food Articles under Primary Article — 15.26
2. Food Products under Manufactured Products — 9.12
3. WPI Food Index (1 +2) – 24.38

The combined index number of WPI Food indices together with the Consumer Food Price Index published by CSO, would help monitor the food inflation effectively  

WPI V/s GDP

Why are the weights of major groups in WPI at variance with their share in GDP?

It is due to the following reasons:

1. The Wholesale Price Index (WPI) is an index covering prices of products/commodities only pertaining to four sectors comprising agriculture, mining, manufacturing and electricity. The other sectors of GDP, in particular, the services sector are not covered under WPI. 
2. The weighting diagram of WPI is not drawn on the basis of gross value added which is a concept followed in GDP. The WPI weights are derived on the basis of turnover or value of output adjusted for net imports.
3. The ratio of gross value added to value of output differs significantly in the sectors covered under WPI.  

Consumer Price Inflation (CPI)

CPI measures the average change in prices of fixed baskets of goods and services that households purchase for the purpose of consumption. It is also called Retail Inflation.

What happened Earlier

There were segment specific CPIs which were compiled regularly. There was four major segment

1. Consumer Price Index for Industrial Workers CPI (IW)
2. Consumer Price Index for Agricultural labour CPI (AL)
3. Consumer Price Index for Rural Labourers CPI (RL)
4. Consumer Price Index for Urban Non Manual Employees CPI(UNME)

What Was the Problem

All these above-mentioned indices depict change in the level of average retail prices of goods and services consumed by specific segments of population, which they refer to. (They are partial indices only and do not present a true picture of consumption of the general population. For example – CPI (RL) – depict price change for Rural labourers only.)

Thus they do not provide a true picture of price fluctuations of various goods and services consumed by the general population in the country over a period of time. 

Then what happened…

The National Statistical Commission (NSC), under Dr. C. Rangarajan, in its Report (2001) recommended the compilation of CPI for rural and urban areas.  

The recommendation of NSC (2001) was further endorsed by the Standing Committee on Finance (2009-10) (15th Lok Sabha, 6th Report on Inflation and Price Rise)  

Accordingly, the Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation started releasing Consumer Price Indices (CPI) on base 2010=100 for all-India and States/UTs separately for rural, urban and combined every month with effect from January, 2011.  

So, the CPI (R) , CPI (U), CPI (C) with Base year 2010 were released in January 2011. 

Then the base CPI was revised from 2010 to 2012.

Why the need for Base Revision for CPI

The CSO started compiling CPI (rural, urban and combined) on Base 2010=100 with effect from January 2011. 

The basket of items and weighing diagrams for this series of CPI was based on Consumer Expenditure Survey (CES) 2004-05. Thus there was a gap of six years between the weight reference year (2004-05) and Price Reference Year (i.e Base year = 2010). 

It is desirable to have a minimum gap between these two reference years so that prices are collected of those items which belong to the basket of consumers in true sense.

The base year has been accordingly revised from 2010 to 2012, and the revised series is released w.e.f. January, 2015.  

So what is the latest standard ?

The CSO has revised the Base Year for CPI (U), CPI (R) and CPI (C) from 2010 to 2012.

The basket of items and their weighing diagrams have been prepared using the data of Consumer Expenditure Survey (CES), 2011-12  

Thus the gap between weight reference Year (2011-12) and Price Reference year (2012) has been minimised to six month (earlier it was 6 years)

Base year – Thus the current Base Year for CPI (R), CPI(U) CPI (C) is 2012.

Nodal Office for Compilation of CPI- The CPI (rural, urban and combined) is released by the National Statistical Office (NSO), Ministry of Statistics and Program Implementation.

Published – CPI figures are released on a monthly basis.

What about other CPIs

At present following CPIs are published

Components of CPI 

The major component in CPI (C) are as follows (along with their weights)

1. Food and Beverages – 45.86
2. Housing – 10.07
3. Fuel and Light – 6.84
4. Clothing and Footwear – 6.53
5. Pan, tobacco and intoxicants – 2.38
6. Miscellaneous – 28.32

Note – Housing Inflation is not considered in CPI (R)

Consumer Food Price Index

It is a component of CPI (C) . It measures the change in the retail prices of the food products only. The Weightage of the Consumer Food Price Index is 39.06

Significance of CPI

1. Since, RBI has adopted Inflation Targeting, CPI (C) is used as nominal anchor for conduct of monetary policy in India. [Monetary Policy Committee is mandated to keep CPI (C) in range 2% – 6%. So CPI is used for inflation targeting.
2. CPI is also used as deflators in the National Accounts.
3. CPI is also used for calculating Dearness Allowance 

WPI V/s CPI

Now let us understand what are the significant difference between WPI and CPI

Producer Price Index

Producer Price Index (PPI) measures the average change in the price of goods and services which is received by the producers.

How is PPI different from WPI?

PPI is different from WPI on following grounds:

Firstly, WPI captures the price changes at the point of bulk transactions and may include some taxes levied and distribution costs up to the stage of wholesale transactions. PPI measures the average change in prices received by the producer and excludes indirect taxes.

Secondly, Weights of items in WPI are based on net traded value whereas in PPI weights are derived from Supply Use Table.

Thirdly, PPI removes the multiple counting biases inherent in WPI. PPIs can be compiled separately for Out PPIs, Input PPIs and Export and ImportPPIs. In build Stage of Processing indices can be compiles to avoid multiple counting.

Finally, WPI does not cover services and whereas PPI includes services.  

How is PPI different from Consumer Price Index (CPI)?

PPI is different from CPI on following grounds:

Firstly, PPI estimates the change in average prices that a producer receives while CPI measures the change in average prices that a consumer pays. The prices received by the producers differ from the prices paid by the consumers on account of various factors such as taxes, trade and transport margin, distribution cost etc..

Secondly, Weights of items in CPI are derived from Consumer Expenditure Surveys whereas for PPI it is calculated on the basis of Supply Use Table.

Finally, CPI based inflation estimates are used as nominal anchor for Monetary Policy formulation in general, whereas PPI estimates are used as deflators and for indexation of contracts etc  

So that’s it for this post folks. Below we are providing you some of the previous year UPSC questions related to this article for practice. Read well and score well.

Test your knowledge with UPSC Previous Year Questions

1. Which of the following brings out the ‘Consumer Price Index Number for Industrial Workers’ (2015)

1. 1. Reserve bank of India
   2. Department of Economic Affairs
   3. The Labour Bureau
   4. The Department of Personnel and Training.

2. With reference to India, consider the following statements: (2010)

1. Wholesale Price Index in India is available on a monthly basis only
2. As compared to CPI (IW), The WPI gives less weight to food articles

Select the correct answer from the code given below

1. 1 only
2. 2 only
3. Both 1 and 2
4. None of the above

Looking forward to your comments and feedback.

See you all in the next post!!