What is Inflation?
- Any inflation rate essentially tells us the rate at which prices have been rising in an economy. As such, an inflation rate is expressed as a percentage. If the prices of onions rose from Rs 10 a kg last year to Rs 15 a kg this year, the inflation rate will be 50%. That’s because a kg of onion is Rs 5 — that is, 50% — more than the base price (Rs 10) in this example.
- For every month, inflation rates are calculated both on a year-on-year basis — how prices have changed over the past year — as well as on a month-on-month basis — how prices have changed over the past month.
- The two most-often used inflation rates in the country are the year-on-year
- Wholesale Price Index (WPI) based inflation rate
- Consumer Price Index (CPI) based inflation rate
- The former is called the wholesale inflation rate and the latter is called the retail inflation rate. These are two different baskets of goods and services.
- The government assigns different weights to different goods and services based on what is relevant for those two types of consumers.
| Difference between WPI and CPI | ||
| Criteria | Wholesale Price Index | Consumer Price Index (CPI) |
| Level | Measures Inflation at Wholesale level | Measures Inflation at Retail level |
| Who Calculates? | Office of Economic Advisor, Ministry of Commerce and Industry | National Statistical Office, MoSPI |
| Base year | 2011-12 | 2012 |
| Released on | 14th of Every Month | 12th of Every Month |
| Number of Items covered | 697 | 299 |
| Categories and their respective weightages | Primary Articles: (22.6%)Manufactured products (64.2%)Fuel and Power (13.2%) | Food and beverages (45.86%)Pan, Tobacco and Intoxicants (2.38%) Clothing and Footwear (6.53%)Housing (10%)Fuel and Light (6.84%): Electricity, LPG, Kerosene etc. (Does not include Petrol and Diesel)Miscellaneous- Education, Healthcare, Transportation and Communication etc. (28.32%) |
| Weightage given to Food Articles | WPI-Food Index (24%): Food articles from “Primary Articles” and “Manufactured Food Product”. | Consumer Food Price Index (CFPI): (39%): Out of 12 sub-groups contained in ‘Food and Beverages’ group, CFPI is based on ten sub-groups, excluding ‘Non-alcoholic beverages’ and ‘Prepared meals, snacks, sweets etc. (For Details, refer to Rau’s Economic Survey Video) |
| Impact of increase in Food items | Less impact on WPI as compared to CPI | Larger impact on CPI |
| Weightage of Fuel and Power | Included in separate category of Fuel and Power (13.2%) | Weightage (~8%): Included in (a) category of Fuel and light and (b) Category of Transportation and Communication (Fuel for Transportation) |
| Highest Weightage | Manufactured products (64.2%) | Food and Beverages (45.9%) |
| Services included | No | Yes |
| Indirect Taxes Included? | No | Yes |
| Targeted by RBI? | No | Yes. The RBI is required to maintain CPI rate of inflation of 4% with a deviation of 2%. |
Recent Developments:
- The RBI’s target inflation rate is 4% with a leeway of two percentage points either side. But as the chart shows, since November 2019, inflation rate has rarely touched 4% — it has never fallen below 4% — and has often stayed outside the 6% mark.
- Ordinarily a single month’s inflation data would not be any more (or any less) important that any other month but, given the fact that India’s monetary policy is balanced on a knife-edge at present, February’s data has gained significance.
- Retail inflation inched lower to 6.44% in February from 6.52% in January, even as it remained above the upper band of the 6% medium-term target of the Reserve Bank of India (RBI) for the second consecutive month.
- While food inflation eased marginally to 5.95% in February from the revised level of 6% in January (earlier 5.94%), inflation for cereals, milk and fruits picked up.
- Among the sub-groups, while vegetables continued to remain in deflationary mode for the fourth consecutive month at (-)11.61% in February, cereals inflation increased to 16.73% in February, the sixth consecutive month of double-digit inflation. Inflation rate for milk and products increased to 9.65% in February from 8.79% a month ago, while that for fruits rose to 6.38% from 2.93% a month ago.
Measures taken by RBI to control Retail Inflation:
- Since May 2022, however, the RBI has been rapidly raising interest rates in a bid to contain high inflation. As a result, the repo rate — or the interest rate that the RBI charges banks when it lends money to them — has gone up by 250 basis points since May. It was 4% in May and stands at 6.5% today. Since repo is the rate at which banks get money, a hike in repo implies higher interest rates for all concerned in the Indian economy.
- While on paper the RBI’s central responsibility is to maintain price stability, it often also concerns itself with boosting economic growth. It can be argued that over the past four years, the RBI has been more concerned about growth than inflation.
- These two concerns pull the RBI in opposite directions. Boosting economic growth requires maintaining low interest rates while containing inflation demands high interest rates.
- However, after retail inflation hit an eight-year high in April 2022, however, the RBI has prioritised containing inflation. But doing this is starting to hurt growth.
Way Forward:
- Though the government’s measures to cool off wheat inflation through open market sales in February and reduction in reserve price is likely to show an impact on inflation with a lag, sticky core inflation and onset of summer may push perishable products prices higher. Also, higher prices of milk and prepared meals are a cause of concern.
- As the core inflation (non-food, non-fuel component) has continued to remain above 6% for the fourth consecutive month, it has prompted expectations of another rate hike of 25 basis points by the RBI in its upcoming policy review in April.
- However, excessive front-loading of rate hikes carries the risk of over-shooting because raising real policy rates to reduce demand has a stronger effect on growth than it does on inflation.
- Also, Inflation print above 6% level for the second straight month indicates a lag in the impact of monetary policy, under which the RBI has increased the repo rate by a cumulative 250 basis points to 6.50% since May last year. That is to say that it takes a few months, sometimes quarters, before a hike in repo rate results in higher interest rates across the board in the economy and in denting consumption and investment demand.
As the headline inflation print is expected to ease March onwards due to a significant base effect, the MPC should wait for a while to let past repo rate hikes take effect.
