Inflation in India

Understanding Inflation

Back to Basics: In 1947, when India got independence, the Indian economy was suffering from low growth, poverty and resource shortages. The salary of an average Indian was very low. Ask your Grand Parents ‘how much they use to earn in the 1950’s?

Today, an average Indian earns 100 times more than what his grandparents use to earn. Does it mean that the standard of living of the people has also risen 100 times? Before reaching to such a conclusion, one must remember that the prices of goods and services in the economy has also risen.

In 1950’s a Delhi-Mumbai air ticket cost in some hundreds, today it cost in thousand. Similarly, the price of Wheat was in few Paisa; it cost around Rupee 50/kg. Therefore, it is not clear from income, that whether the standard of living of people have risen or not.

To compare the salary of your grandparents to yours, we need some measure of purchasing power or price. The meaningful measure that can perform the task is “Consumer Price Index”.

Consumer Price Index: CPI is used to monitor changes in the cost of living over time. When the CPI rises, the average Indian family has to spend more on goods and services to maintain the same standard of living. The economic term used to define such a rising prices of goods and services is Inflation.

Inflation: Inflation is when the overall general price level of goods and services in an economy is increasing. As a consequence, the purchasing power of the people are falling. For example, if the inflation rate is 4 percent, then a basket of goods (food, clothing, footwear, tobacco, electricity etc) that costs Rs 100 in year 2016-17 will cost Rs 104 in the year 2017-18. As more money is required to purchase the same basket of goods and services, we say the value of money/purchasing power has fallen.

Inflation Rate: Inflation Rate is the percentage change in the price level from the previous period. If a normal basket of goods was priced at Rupee 100 last year and the same basket of goods now cost Rupee 120, then the rate of inflation this year is 20%.

Inflation Rate= {(Price in year 2 – Price in year 1)/ Price in year 1} *100

Whole sale Price Index: WPI is used to monitor the cost of goods and services bought by producer and firms rather than final consumers. The WPI inflation captures price changes at the factory/wholesale level.

The WPI and CPI are different indices and are used for different purpose.

1. The WPI and CPI use different basket of goods to calculate the inflation.
2. The weights assigned to food, fuel, manufacturing items etc. are different. For example, the weight of food in CPI is far higher at 46% than in WPI at 24%.
3. The WPI inflation does not capture price changes of services but the CPI does.

GDP Deflator: Another important measure of calculating standard of living of people is GDP Deflator. GDP Deflator is the ratio of nominal GDP to real GDP. The nominal GDP is measured at the current prices whereas the real GDP is measured at the base year prices. Therefore, GDP Deflator reflects the current level of prices relative to prices in a base year. Example, In India the base year of calculating deflator is 2011-12.

The Difference

Producer Price Index

PPI measures the average change in the sale price of goods and services either as they leave the place of production or as they enter the place of production. It estimates the change in average price that producer receives. PPI measure the average change in the prices received by the producer and excludes any type of indirect taxes. Moreover, PPI includes services also.

The PPI measure the price changes from the perspective of the seller and differs from CPI which measures price changes from buyer perspective.

National Housing Banks: Residex

It is India’s first housing price index which is an initiative of the National Housing Bank undertaken at the behest of Ministry of Finance. The index was formulated under the guidance of Technical Advisory Committee. It was launched in 2007 and updated periodically with 2007 as base year. The coverage of Residex expands to 26 cities.

Initially, NHB RESIDEX was computed using market data, which 2010 onwards, was shifted to valuation data received from banks and housing finance companies (HFCs). Thereafter, data was sourced from Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI) from 2013 to 2015.

The scope has been widened under NHB RESIDEX brand, to include housing price indices (HPI), land price indices (LPI) and building materials price indices (BMPI), and also housing rental index (HRI).

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University