Letter of Transmittal

To, The Regional Director, Reserve Bank of India, Patna (Bihar)

Report of Young Scholar, 2011 on Inflation Indices and the Common Man

Dear sir, I have great pleasure submitting the report on Inflation Indices and the Common Man. As the world economy has begun to stabilize in the aftermath of the global crisis, inflation has re-emerged as a major concern particularly in the fast-recovering developing economies. Inflation is normally related with high prices which causes decline in the purchasing power or the value of money. Inflation or inflation rate is calculated as the percentage change of a certain price index. There are two ways for calculating inflation rate .They are Consumer Price Index (CPI) and Wholesale Price Index (WPI). In this project, I have analyzed the measures that are used to calculate the inflation or inflation rate.

Finally I am very thankful to RESERVE BANK OF INDIA for giving me this rare opportunity for which I would be highly indebted throughout my life.

Yours sincerely,

Pintu Kumar RBI YOUNG SCHOLAR,2011

K.Satyanarayana Manager (Estate Dept.) Guide

RESERVE BANK OF INDIA

PROJECT REPORT

INFLATION INDICES AND THE COMMON MAN

PREPARED BYPINTU KUMAR RBI YOUNG SCHOLAR RBI REGIONAL OFFICE, PATNA
2

OUR PREAMBLE

to regulate the issue of Bank Note and keeping of reserve With a view to securing monetary stability in India And generally to operate the currency and credit System of the country to its advantage.

-RESERVE BANK OF INDIA

DECLARATION
I hereby affirm that this project work titled Inflation Indices and the Common Man carried out by me under the supervision of Shri K.Satyanarayana, Manager (Estate Department), being submitted to the Reserve Bank of India for the award of the RBI Young Scholar 2011, is original and has not been submitted either in part or in full to any other institution or to this institution.

PINTU KUMAR

PREFACE
Without a sound and effective banking system in India, it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors. For the past three decades, India's banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons of India's growth process. The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India. Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dials a pizza. Money has become the order of the day. Banking in India originated in the last decades of the 18th century. The oldest bank in existence in India is the State Bank of India, a government-owned bank that traces its origins back to June 1806 and that is the largest commercial bank in the country. Central banking is the responsibility of the Reserve Bank of India, which in 1935 formally took over these responsibilities from the then Imperial Bank of India, relegating it to commercial banking functions. After India's independence in 1947, the Reserve Bank was nationalized and given broader powers. In 1969 the government nationalized the 14 largest commercial banks; the government nationalized the six next largest in 1980.

ACKNOWLEDGEMENT
First of all I would like to thank Reserve bank of India to allow me to be a part of such a reputed institution, the Apex Bank of India, which gave me the chance to work on the project titled INFLATION INDICES AND THE COMMON MAN. I sincerely thank the Governor of Reserve Bank of India and Shri Mohit Kumar Singh, Regional Director Patna and Jharkhand office for facilitating and providing an opportunity to learn in the form of a training programme.I further thank Shri Suramya Mohan, AGM (RPCD) for helping me in the project along with RBI. A special acknowledgement goes to Shri K.Satyanarayana, Manager (Estate Department) for helping me to understand the various aspects related to Inflation and guiding me to undertake the project in the right direction. He further helped me to collect data and information related to my topic and also helped me to analyze it and give it a proper shape. I am also thankful to Department of Administration and Personnel Management (DAPM), for guidance and hospitality provided throughout the period of the internship. In particular, I would like to thank Shri Praveen Kumar (DAPM), Manager and Shri K. S. Gauri (DAPM) , Assistant Manager for their encouragement and guidance. Without their friendly and moral support, this project would have never been easier and a joyful and memorable learning. No amount of thank givings would compensate the constant help and encouragement received from Shri Ashwani Kumar Dixit, Assistant Manager (DIT) and whole DIT cell for computer assistance. I am also thankful to my colleagues Abhishek Kumar Singh, Abhinav Krishna, Jitendra Kumar, Rameshwar Dayal Lodi and Niyati Kumari for their encouragement and support to utilize this opportunity. Finally I once again thank RESERVE BANK OF INDIA for giving me this rare opportunity to study under RBI YOUNG SCHOLAR AWARD SCHEME 2011 for which I would be highly indebted throughout my life.

PINTU KUMAR

SYNOPSIS
Title: Inflation Indices and the common man
In economics inflation is a rise in the general level of prices of goods and services in an economy over a period. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate the annualized percentage change in a general price index. Inflation or inflation rate is calculated as the percentage change of a certain price index. There are two ways for calculating inflation rate .They are Consumer Price Index (CPI) and Wholesale Price Index (WPI). A consumer price index measures changes in the price level of consumer goods and services purchased by households. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. CPI is a fixed quantity price index and considered by some a cost of living index. Under CPI, an index is scaled so that it is equal to 100 at a chosen point in time, so that all other values of the index are a percentage relative to this one. CPI is used by many countries to calculate inflation such as USA, UK, Japan, France etc. Wholesale price index is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 676 commodities data on price level is tracked through WPI, which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy. Currently the base year on which inflation is calculated is 2004-05. Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions), and encouraging investment in non-monetary capital projects. Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine

low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth. Today, most mainstream economists favour a low, steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements. So in order to highlight how inflation affects the common man and his living I am working on Inflation indices and the common man.

CONTENTS
SI.NO.
1 2 3 4

SUBJECTS
Introduction of RBI History of Inflation Meaning ,definition and features Causes of Inflation (a) Factors affecting Demand (b) Factors affecting Supply Measures to control Inflation Types of Inflation Inflation Indices (a)Wholesale Price Index(WPI) (b)Commodities along with their weightage in WPI (c)Limitations of WPI (d)Consumer Price Index (e)Commodities along with their weightage in CPI (f)CPI vs. WPI Effects of Inflation on different Income Groups Recommendations Conclusion Bibliography

PAGE NO.
1 2 3 4 6 8 11 12 14 15 15 16 17 18 19 20 21

5 6 7

8 9 10 11

INTRODUCTION OF RBI
(THE CENTRAL BANK OF INDIA)
The central bank of the country is the Reserve Bank of India (RBI). The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of THE RESERVE BANK OF INDIA ACT, 1934. Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the Government of India. The Central Office of the Reserve Bank has been in Mumbai since inception. The Central Office is where the Governor sits and is where policies are formulated. Now it has 22 regional offices, most of them in state capitals. The Bank was constituted for the need of following: y y y To regulate the issue of banknotes. To maintain reserves with a view to securing monetary stability. To operate the credit and currency system of the country to its advantage.

FUNCTIONS
y y y y y y y Banker to the government. Bankers bank. Lender of the last resort. Custodian of foreign reserves. Regulator and Supervisor of the financial system. Manager of exchange control Issue of currency

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INFLATION
HISTORY
Increase in the quantity of money or in the overall money supply (or debasement of the means of exchange) has occurred in many different societies throughout history, changing with different forms of money used. For instance, when gold was used as currency, the government could collect gold coins, melt them down, mix them with other metals such as silver, copper or lead, and reissue them at the same nominal value. By diluting the gold with other metals, the government could issue more coins without also needing to increase the amount of gold used to make them. When the cost of each coin is lowered in this way, the government profits from an increase in seigniorage. This practice would increase the money supply but at the same time the relative value of each coin would be lowered. As the relative value of the coins becomes less, consumers would need to give more coins in exchange for the same goods and services as before. These goods and services would experience a price increase as the value of each coin is reduced. Historically, infusions of gold or silver into an economy have also led to inflation. From the second half of the 15th century to the first half of the 17th, Western Europe experienced a major inflationary cycle referred to as the "price revolution, with prices on average rising perhaps six fold over 150 years. This was largely caused by the sudden influx of gold and silver from the New World into Habsburg Spain. The silver spread throughout a previously cash starved Europe, and caused widespread inflation. By the nineteenth century, economists categorized three separate factors that cause good, a change in the price of money which then was usually a fluctuation in the commodity price of the metallic content in the currency, and currency depreciation resulting from an increased supply of currency relative to the quantity of redeemable metal backing the currency. Following the proliferation of private bank note currency printed during the American Civil War, the term "inflation" started to appear as a direct reference to the currency depreciation that occurred as the quantity of redeemable bank notes outstripped the quantity of metal available for their redemption. The term inflation then referred to the devaluation of the currency, and not to a rise in the price of goods.

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Meaning and Definition

Inflation is normally related with high prices which causes decline in the purchasing power or the value of money. Inflation refers to the substantial and rapid increase in the general price level. It is primarily a monetary phenomenon. Prices keep on rising due to excess supply of money and lower production of exchangeable goods. According to Crowther, Inflation is a state in which the value of money is falling, i.e., prices are rising. According to Pigou, Inflation takes place when money income is expanding relatively to the output of work done by the productive agents for whom it is the payment.

Features
(1) The quantity of money is increasing but the production is static and increasing. (2) The quantity of money is stable but the production is declining. (3) If the quantity of money is declining and the production is also declining but decline of production is higher than the decline in quantity of money. (4) If the quantity of money is increasing and the volume of production is declining. (5) If the quantity of money is in excess of demand or requirements. (6) If the quantity of money as well as production is increasing but the rate of increase in production is lesser than the rate of increase in the quantity of money.

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CAUSES OF INFLATION

Inflation is caused when the aggregate demand exceeds the aggregate supply of goods and services. We analyze the factors which lead to increase in demand and the shortage of supply.

Factors Affecting Demand

Both Keynesians and monetarists believe that inflation is caused by increase in the aggregate demand. They point towards the following factors which raise it.

(1) Increase in money supply

Inflation is caused by an increase in the supply of money which leads to increase in aggregate demand. The higher the growth rate of the nominal money supply, the higher is the rate of inflation.

(2) Increase in Disposable Income

When the disposable income of the people increases, it raises their demand for goods and services. Disposable income may increase with the rise in national income or reduction in taxes or reduction in the saving of the people.

(3) Increase in Government Expenditure

Government activities have been expanding much with the result that government expenditure has also been increasing at a phenomenal rate, thereby raising aggregate demand for goods and services. Governments of both developed and developing countries are providing more facilities under public utilities and social services, and also nationalizing industries and starting public enterprises with the result that they help in increasing aggregate demand.

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(4) Increase in Consumer Spending

The demand for goods and services increases when consumer expenditure increases. Consumers may spend more due to conspicuous consumption or demonstration effect. They may also spend more when they are given credit facilities to buy goods on hire-purchase and installment basis.

(5) Cheap Monetary Policy

Cheap monetary policy or the policy of credit expansion also leads to increase in the money supply which raises the demand for goods and services in the economy. When credit expands, it raises the money income of the borrowers which, in turn, raises aggregate demand relative to supply, thereby leading to inflation. This is also known as credit-induced inflation.

(6) Deficit Financing

Deficit financing means spending more than revenue. In this case government of India accepts more amount of money from the Reserve Bank India (RBI) to spend for undertaking public projects and only the government of India can practice deficit financing in India. The high doses of deficit financing which may cause reckless spending, may also contribute to the growth of the inflationary spiral in a country. This is also known as deficit- induced inflation.

(7) Expansion of the Private Sector

The expansion of the private sector also tends to raise the aggregate demand. For huge investments increase employment arid income, thereby creating more demand for goods and services. But it takes time for the output to enter the market.

(8) Black Money

It is widely condemned that black money in the hands of tax evaders and black marketers as an important source of inflation in a country. Black money encourages lavish spending, which causes excess demand and a rise in prices.
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(9) Repayment of Public Debt

Whenever the government repays its past internal debt to the public, it leads to increase in the money supply with the public. This tends to raise the aggregate demand for goods and services. These, in turn, create more demand for goods and services within the economy.

Factors Affecting Supply

There are also certain factors which operate on the opposite side and tend to reduce the aggregate supply. Some of the factors are as follows:

(1) Shortage of Factors of Production

One of the important causes affecting the supplies of goods is the shortage of such factors as labor, raw materials, power supply, capital etc. They lead to excess capacity and reduction in industrial production.

(2) Industrial Dispute

In countries where trade unions are powerful, they also help in curtailing production. Trade unions resort to strikes and if they happen to be unreasonable from the employers' viewpoint and are prolonged, they force the employers to declare lock-outs. In both cases, industrial production falls, thereby reducing supplies of goods. If the unions succeed in raising money wages of their members to a very high level than the productivity of labor, this also tends to reduce production and supplies of goods.

(3) Natural Calamities

Drought or floods is a factor which adversely affects the supplies of agricultural products. The latter, in turn, create shortages of food products and raw materials, thereby helping inflationary pressures .

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(4) Artificial Scarcities

Artificial scarcities are created by hoarders and speculators who indulge in black marketing. Thus they are instrumental in reducing supplies of goods and raising their prices.

(5) Increase in Exports

When the country produces more goods for export than for domestic consumption, this creates shortages of goods in the domestic market. This leads to inflation in the economy.

(6) Lop-Sided Production

If the stress is on the production of comfort, luxuries, or basic products to the neglect of essential consumer goods in the country, this creates shortages of consumer goods. This again causes inflation.

(7) Law of Diminishing Returns

If industries in the country are using old machines and outmoded methods of production, the law of diminishing returns operates. This raises cost per unit of production, thereby raising the prices of products.

(8) International Factors

In modern times, inflation is a worldwide phenomenon. When prices rise in major industrial countries, their effects spread to almost all countries with which they have trade relations. Often the rise in the price of a basic raw material like petrol in the international market leads to rise in the price of all related commodities in a country.

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MEASURES TO CONTROL INFLATION

Inflation can be controlled by increasing the supplies and reducing money incomes in order to control aggregate demand. The various methods are usually grouped under three heads: Monetary measures, fiscal measures and other measures.

Monetary Measures
Monetary measures aim at reducing money incomes . (a) Monetary Policy:- One of the important monetary measures is monetary policy. The central bank of the country adopts a number of methods to control the quantity and quality of credit. For this purpose, it sells securities in the open market, raises the reserve ratio, and adopts a number of selective credit control measures, such as raising margin requirements and regulating consumer credit. Monetary policy may not be effective in controlling inflation, if inflation is due to cost-push factors. Monetary policy can only be helpful in controlling inflation due to demand-pull factors.

(b) Demonetization of Currency: - However, one of the monetary measures is to demonetize currency of higher denominations. Such a measure is usually adopted when there is abundance of black money in the country.

(c) Issue of new currency:- The most extreme monetary measure is the issue of new currency in place of the old currency. Under this system, one new note is exchanged for a number of notes of the old currency. The value of bank deposits is also fixed accordingly. Such a measure is adopted when there is an excessive issue of notes and there is hyperinflation in the country. It is very effective measure. But is inequitable for its hurts the small depositors the most.

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Fiscal Policy
Monetary policy alone is incapable of controlling inflation. It should, therefore, be supplemented by fiscal measures. Fiscal measures are highly effective for controlling government expenditure, personal consumption expenditure, and private and public investment. The principal fiscal measures are the following: (a) Reduction in unnecessary expenditure:- The government should reduce unnecessary expenditure on non-development activities in order to curb inflation. This will also put a check on private expenditure which is dependent upon government demand for goods and services. But it is not easy to cut government expenditure. Though economy measures are always welcome but it becomes difficult to distinguish between essential and non-essential expenditure. Therefore, this measure should be supplemented by taxation. (b) Increase in taxes:- To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes should be raised and even new taxes should be levied, but the rates of taxes should not be so high as to discourage saving, investment and production. Rather, the tax system should provide larger incentives to those who save, invest and produce more. Further, to bring more revenue into the tax-net, the government should penalize the tax evaders by imposing heavy fines. Such measures are bound to be effective in controlling inflation. To increase the supply of goods within the country, the government should reduce import duties and increase export duties. (c) Increase in savings:- Another measure is to increase savings on the part of the people. This will tend to reduce disposable income with the people, and hence personal consumption expenditure. But due to the rising cost of living, people are not in a position to save much voluntarily. Keynes, therefore, advocated compulsory savings or what he called deferred payment' where the saver gets his money back after some years. For this purpose, the government should float public loans carrying high rates of interest, start saving schemes with prize money, or lottery for long periods, etc. It should also introduce compulsory provident fund, provident fund-cum-pension schemes, etc. compulsorily. All such measures to increase savings are likely to be effective in controlling inflation. (d) Surplus Budget:- An important measure is to adopt anti-inflationary budgetary policy. For this purpose, the government should give up deficit financing and instead have surplus budgets. It means collecting more in revenues and spending less. (e) Public Debt:- At the same time, it should stop repayment of public debt and postpone it to some future date till inflationary pressures are controlled within the
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economy. Instead, the government should borrow more to reduce money supply with the public. Like the monetary measures, fiscal measures alone cannot help in controlling inflation. They should be supplemented by monetary, non-monetary and non fiscal measures.

Other Measures
The other types of measures are those which aim at increasing aggregate supply and reducing aggregate demand directly. (a) To Increase Production:- The following measures should be adopted to increase production: (i) One of the foremost measures to control inflation is to increase the production of essential consumer goods like food, clothing, kerosene oil, sugar, vegetable oils, etc. (ii) If there is need, raw materials for such products may be imported on preferential basis to increase the production of essential commodities. (iii) Efforts should also be made to increase productivity. For this purpose, industrial peace should be maintained through agreements with trade unions, binding them not to resort to strikes for some time. (iv) The policy of rationalization of industries should be adopted as a long-term measure. Rationalization increases productivity and production of industries through the use of brain, brawn and bullion. (v) All possible help in the form of latest technology, raw materials, financial help, subsidies, etc. should be provided to different consumer goods sectors to increase production. (b) Rational Wage Policy :- Another important measure is to adopt a rational wage and income policy. Under hyperinflation, there is a wage-price spiral. To control this, the government should freeze wages, incomes, profits, dividends, bonus, etc. But such a drastic measure can only be adopted for a short period and by antagonizing both workers and industrialists. Therefore, the best course is to link increase in wages to increase in productivity. This will have a dual effect. It will control wage and at the same time increase productivity, and hence production of goods in the economy.
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(c) Price Control:- Price control and rationing is another measure of direct control to check inflation. Price control means fixing an upper limit for the prices of essential consumer goods. They are the maximum prices fixed by law and anybody charging more than these prices is punished by law. But it is difficult to administer price control. (d) Rationing:- Rationing aims at distributing consumption of scarce goods so as to make them available to a large number of consumers. It is applied to essential consumer goods such as wheat, rice, sugar, kerosene oil, etc. It is meant to stabilize the prices of necessaries and assure distributive justice. But it is very inconvenient for consumers because it leads to queues, artificial shortages, corruption and black marketing. Keynes did not favour rationing for it "involves a great deal of waste, both of resources and of employment."

TYPES OF INFLATION

Demand-Pull Inflation:- This type of inflation occurs when total demand for goods and services in an economy exceeds the supply of the same. When the supply is less, the prices of these goods and services would rise, leading to a situation called as demandpull inflation. This type of inflation affects the market economy adversely during the wartime. Cost-Push Inflation:- As the name suggests, if there is increase in the cost of production of goods and services, there is likely to be a forceful increase in the prices of finished goods and services. This type of inflation may or may not occur in conjunction with demand-pull inflation. Hyper Inflation:- It is an extremely accelerated form of inflation, occurring when the country imposing it is in desperate need of money-either to pay debts, fund development and so on. Stagflation:- This is the situation in which the inflation continues to rise although the economy is in recession. This type of inflation can have disastrous effects but is generally a short lived form of inflation as it could potentially lead to a financial crisis.

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INFLATION INDICES
Inflation rate is the rate at which prices of goods and services increase in its economy. It is an indication of the rise in the general level of prices over time. Mathematically, inflation or inflation rate is calculated as the percentage rate of change of a certain price index. These indices are Wholesale Price Index and Consumer Price Index.

Wholesale Price Index WPI was first published in 1902, and was one of the more economic indicators available to policy makers until it was replaced by most developed countries by the Consumer Price Index in the 1970s. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 676 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy.

Inflation rate in India from 2008 to 2011

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Criteria for selection of Wholesale Price Outlets The following criteria were used to determine the wholesale price outlets: (1) Popularity of an establishment along the line of goods to be priced (2) Consistency of the stock (3) Permanency of the outlet (4) Cooperativeness of the price informant (5) Location Criteria for selection of commodities in the Market Basket The commodities in the market basket were selected according to the following criteria: (1) Popularity of the variety of the commodity (implies representativeness with respect to the commodity) (2) Consistency of supply in the market (sustained availability of supply from the base period to the present) (3) Relatively high market share of the commodity. Calculation of inflation rate by WPI In this method, a set of 676 commodities and their price changes are used for the calculation. The selected commodities are supposed to represent various strata of the economy and are supposed to give a comprehensive WPI value for the economy. WPI is calculated on a base year and WPI for the base year is assumed to be 100. To show the calculation, lets assume the base year to be 1970. The data of wholesale prices of all the 676 commodities in the base year and the time for which WPI is to be calculated is gathered. Let's calculate WPI for the year 1980 for a particular commodity, say wheat. Assume that the price of a kilogram of wheat in 1970 = Rs 5.75 and in 1980 = Rs 6.10 The WPI of wheat for the year 1980 is, (Price of Wheat in 1980 Price of Wheat in 1970)/ Price of Wheat in 1970 x 100 i.e. (6.10 5.75)/5.75 x 100 = 6.09 Since WPI for the base year is assumed as 100, WPI for 1980 will become 100 + 6.09 = 106.09. In this way individual WPI values for the remaining 434 commodities are calculated and then the weighted average of individual WPI figures are found out to arrive at the overall Wholesale Price Index. Commodities are given weightage depending upon its influence in the economy. If we have the WPI values of two time zones, say, beginning and end of year, the inflation rate for the year will be,
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(WPI of end of year WPI of beginning of year)/WPI of beginning of year x 100 For example, WPI on Jan 1st 1980 is 106.09 and WPI of Jan 1st 1981 is 109.72 then inflation rate for the year 1981 is, (109.72 106.09)/106.09 x 100 = 3.42% and the inflation rate for the year 1981 is 3.42%(APPROX.)

This is how we calculate the inflation rate of a period by using the Wholesale price index.

Commodities along with their weightage in WPI

S.NO. 1 (a) (b) (c) 2 (a) (b) (c) 3 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l)

Commodities Primary Articles: Food Articles Non-Food Articles Minerals Sub Total Fuel, Power, Light & Lubricants Coal Mining Mineral Oils Electricity Sub Total Manufactured Products Food Products Beverages, Tobacco and Tobacco Products Textiles Wood and Wood Products Paper and Paper Products Leather and Leather Products Rubber and Plastic Products Chemicals and Chemical Products Non-Metallic Mineral Products Machinery and Machine Tools Transport Equipment and Parts Basic Metals and Alloys Sub Total GRAND TOTAL

Weightage 14.34 4.25 1.53 20.12 2.09 9.36 3.46 14.91 9.97 1.76 7.33 0.58 2.04 0.84 2.99 12.02 2.55 8.93 5.21 10.75 64.97 100.00

Source: The Office of the Economic Advisor, Ministry of Commerce and Industry
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Limitations of WPI
(1)WPI does not include services while they are the most essential part of an economy. (2)WPI follows a fixed weightage of all the commodities while the economy is undergoing many structural changes. (3)The base year is chosen after a decade which is a very long time. (4)The inflation rate is measured at the Intermediate demand level and not at the Final demand level. (5) Another problem is that the share of expenditure of commodities may change overtime. For instance, the expenditure on computers, which were seldom available before 1990s but now have a significant share in the expenditure of an urban Indian. So the weights of these indices need to be changed over time.

Consumer Price Index

A Consumer Price Index (CPI) measures changes in the price level of consumer goods and services purchased by households. The CPI is defined by the United States Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. Sub-indexes and sub-subindexes are computed for different categories and sub-categories of goods and services, being combined to produce the overall index with weights reflecting their shares in the total of the consumer expenditures covered by the index. CPI is a fixed quantity price index and considered by some a cost of living index. Under CPI, an index is scaled so that it is equal to 100 at a chosen point in time, so that all other values of the index are a percentage relative to this one. It is one of several price indices calculated by most national statistical agencies. The annual percentage change in a CPI is used as a measure of inflation. A CPI can be used to index (i.e., adjust for the effect of inflation) the real value of wages, salaries, pensions, for regulating prices and for deflating monetary magnitudes to show changes in real values. In most countries, the CPI is, along with the population census and the USA National Income and Product Accounts one of the most closely watched national economic statistics.

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Calculation of inflation rate by CPI

CPI of current year- CPI of previous year/CPI of previous year 100 Let CPI number of current year be 196.8 and of previous year be 190.3; Then Inflation Rate = 196.8 190.3 / 190.3 100 = 6.5 / 190.3 100 = 3.4 %

Commodities along with their weightage in CPI

SI.NO. 1 2 3 4 5 6 7 8

Commodities Food and Beverages Housing Apparel, Textile and Footwear Transport Recreation and Entertainment Education and Communication Medical care Other goods and services Grand Total

Weightage 14.59 42.074 3.772 17.199 6.625 6.288 6.294 3.229 100.00

Source: United States Department of Labor-MAY 2011

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CPI vs. WPI

(1) WPI does not properly measure the exact price an end-consumer will experience because it is at the wholesale level, whereas, CPI actually measures the increase in price that a consumer will ultimately have to pay for. (2) Many commodities included in WPI have ceased to be important from the consumer point of view, whereas, CPI commodities are changed as the consumption pattern follows. (3) In CPI, the commodity basket is reviewed after every 4-5 years which is not in the case of WPI. (4) The WPI doesnt take the price of services into consideration, which now accounts for 60 percent of the GDP. Also, it is too general and cannot be used for specific purposes. For example, if an individual wants to know the trends in office stationery products, then WPI may not capture the correct or complete picture. (5) The WPI is compiled and published by Office of the Economic Advisor on a weekly basis while the CPI is compiled and published by the Labour Bureau on a monthly basis in India. The CPI is published for rural, agricultural and industrial workers. (6) Wholesale price index measures inflation at each stage of production while Consumer price index measures inflation only at final stage of production. (7) Wholesale price index is the middle point of the sum of all the goods bought by the traders whereas consumer price index is the middle point of the sum of all the goods bought by consumers. (8) There are only few countries that use WPI to calculate inflation rates whereas many nations have already shifted to using CPI. (9) WPI is said to result an erroneous measure while CPI will describe actual cost of living and inflation rate more accurately.

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Effects of Inflation on different income groups

(1) Wage and Salary Earners:- Wage and Salary Earners suffer a lot during inflation because wages and salaries generally do not rise in the same proportion in which the cost of living rises. For example, the National Floor Level of Minimum Wage has increased from Rs.80 to Rs.115 per day during the last 4-5 years but the inflation rate during this period rose from 6.39% to 9.04%.So there is a time lag between these two. If the workers and salary earners are well organized into power trade-unions, they may not suffer much during inflation but if they are unorganized, they suffer very deeply.

(2) Pensioned-Income Groups:- These groups have the hardest hit as their incomes are fixed which do not bear any relationship with the rising cost of living. They have to cut- off the consumption of some essential daily use products in order to meet up the hike in prices.

(3) Entrepreneurs:- Inflation is welcomed by entrepreneurs and businessmen because they stand to profit by rising prices. They find that the value of their inventories and stock of goods is rising in money terms. They also find that prices are rising faster than the costs of production, so that their profit is greatly enhanced.

(4) Farmers:- Farmers are generally the gainers during inflation. The prices of farm products go up while the costs incurred by them do not go up to the same extent. But there is a time-lag between rise in prices and the increase in costs. In this, the big farmers who have huge investment earn more than the small farmers whose turnover is low.

(5) Investors:- Those who invest in debentures and fixed-interest bearing securities, bonds, etc, lose during inflation. However, investors in equities benefit because more dividend is yielded on account of high profit made by joint-stock companies during inflation.

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RECOMMENDATIONS

 The Reserve Bank of India should review the commodity basket of WPI after every three years and not after a decade. This will cover up all the structural and recent changes in the consumption pattern.  The base year to be used should not include any abnormal changes, price fluctuations etc.  The Reserve Bank of India should increase the reserve requirements of the demand deposits, the commercial banks shall now be required to keep larger reserves with the RBI and to that extent their power to create credit shall become limited but during this they should keep in view the growth rate of the country.  We have poor infrastructure. If infrastructure improves, the cost of goods and services comes down. We need to quickly build highways, power plants and ports. For this purpose, the government should allow infrastructure companies to float tax-free infrastructure bonds.  The government should discourage the export of those goods particularly whose prices are rising at an alarming rate and are also not available in the domestic market for consumption and not only this but also encourage their import from the foreign countries.  The government should take measures to introduce farm sector reforms as a priority. This may include use of technology in farming, use of high yielding variety seeds, non dependence on monsoon etc. This will boost the overall farm productivity with higher yields and reduced costs. As a result, this may bring down the prices of essential products and in turn having a positive effect on efforts to bring down the inflation.  Credit to agricultural sector should be made more target oriented in order to bring down the input costs. Measures to cover crop failures due to drought conditions, floods etc should be linked along with agricultural credit.

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CONCLUSION

As the world economy has begun to stabilize in the aftermath of the global crisis, inflation has re-emerged as a major concern particularly in the fast-recovering developing economies. At present, the major pressure on prices is emanating from the food and energy sectors both at global and domestic levels. However, it has now also advanced towards the core sector. The Reserve Bank of India is trying to control inflation supportive of growth momentum. This has to be seen in the context of more than expected inflation in the recent past, relative stickiness of prices, especially of food and building of wider inflationary expectations in the economy even as monetary policy tools are being used proactively to manage demand and damper inflationary pressures in the economy. Inflation has been elevated for over a year and RBI has responded by raising the repo rate, or the rate at which it lends to banks, ten times. It has tried to bring down the aggregate demand. Lower demand acts a check on rising prices. Inflationary pressures in the economy are also emanating in part from supply-side constraints, especially in food and other primary articles, as well as the transmission of higher global food, oil and other commodity prices. These considerations therefore are complicating the issue in the near term. Therefore, it is important for the Reserve Bank of India to ensure a low inflation environment as a pre-condition for sustained high growth.

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BIBLIOGRAPHY 1. www.rbi.org 2. www.wikipedia.com 3. The Economic Times 4. Money and Banking M. L. Seth 5. Economic Survey of Delhi 2005-2006 6. Economic Survey 2010-2011 7. United States Department of Labor 8. SME Times 9. livemint.com 10. The Finance Blog 11. Business Advice Forum 12. General Knowledge Today 13.Trading Economics.com; Indian Ministry of Labour

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