Moneycontrol
Jul 14, 2017 11:41 AM IST | Source: Moneycontrol.com

What is inflation and how exactly is it calculated?

The lowest inflation rate, technically deflation was recorded in May 1976 at minus 11.31 percent. On the other hand, highest inflation rate observed was 34.68 percent in September 1974.


In India, generally, two kinds of indices are used to measure inflation—Wholesale Price Index (WPI) and Consumer Price Index (CPI).

What is Wholesale Price Index (WPI)?

An index used by the Reserve Bank of India till 2014 to make its monetary policy, WPI, as the name suggests, measures the prices at the wholesale level. WPI is the price of a representative basket of wholesale goods. It takes a basket of 697 items into account and shows the combined prices.

The basket used in WPI is composed of three groups: Manufactured Products (65 percent of total weight), Primary Articles like food, etc. (20.1 percent), and Fuel and Power (14.9 percent). The WPI is calculated by the Ministry of Commerce and Industry.

How Indian Economy Is Measured

The main reason RBI, under ex-governor Raghuram Rajan, shifted to Consumer Price Index is because it neglects services and the bottlenecks between a wholesaler and a retailer.

Also Read: June retail inflation at record low; falls to 1.54%

What is Consumer Price Index (CPI)?

CPI, based on 260 commodities including certain services, measures the change in prices at the retail level. Prices of sample goods and services are collected periodically (usually every month) by the Ministry of Statistics and Programme Implementation, and the change, if any, is noted.

The base year of CPI was changed to 2012 from 2010. Base year for WPI and IIP (Index of Industrial Production) was also changed to 2012 in April this year.

A base year is used to compare the measure of rates. For simple understanding, this can be taken as ‘first’ year in the time set. Prices in the base year are often taken as 100 to simplify calculations.

Inflation

Inflation is the measure of the rate of increase in the prices of goods and services. However, when there is a decrease in the rate it is called deflation.

Authorities in India use price indices to determine the change of rates of commodities and services, thus the inflation or deflation is calculated. For example, if the rate of rice a year ago was Rs 20 a kilo and currently it is Rs 22 a kilo, the inflation in the rice prices would be at 10 percent.

The overall inflation also called the Headline Inflation is measured taking into the account the rise in food, fuel and other commodities.

While calculating inflation, the weight of a product is considered higher if consumers expend larger share of their income on that product. For example, household expenditure is higher on food and fuel than postcards or shaving creams, hence given more weights while calculating the inflation. Ergo, the impact of the change in food or fuel prices is greater on inflation than same change in shaving cream.

The retail inflation rate in June is 1.54 percent, lowest in last 18 years. The lowest inflation rate, technically deflation, was recorded in May 1976 at (-)11.31 percent. On the other hand, highest inflation rate observed was 34.68 percent in September 1974.
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