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Mismeasuring inflation

One of the most misleading aspects of the discussion on the current inflationary spiral is the way the numbers are treated. Most of the discussion centres on the movement of the Wholesale Price Index (WPI), which is released every Friday by the Union Commerce Ministry. The reliance on the WPI by the government and the media for measuring inflation, despite its serious shortcomings, is not merely a matter of statistical propriety. It hides the true extent of the erosion of incomes by inflation.

There is no such thing as a general rate of inflation, except insofar as it relates to the framing of macroeconomic policy in a very broad sense. Two issues matter for any meaningful discussion on assessing the impact of price movements. First, who — or which section — are we referring? Secondly, what prices, among the many in a large and diverse economy, are important? Of course, the two issues are linked because the relevant prices vary for different sections. And this is what a price index, relevant to a specific social group, seeks to do.

Foodgrains will obviously constitute a significant portion of the basket of commodities purchased by a poor household. The price of consumer durables, on the other hand, may constitute a bigger share of the consumption basket of an urban upper middle class household. The point is that price movements, in a generalised sense, make no sense.

The focus on the Wholesale Price Index as a barometer of price trends is fundamentally flawed because it is a producer index, not a consumer price index relevant to any of the major section of consumers — industrial workers, middle class workers, agricultural, or rural non-agricultural workers. The arrangement of the relative weights for different sets of commodities in the WPI loads them heavily towards manufactured goods. Manufactured products account for almost two-thirds of the overall index, whereas “food articles” have a weight of only 15 per cent.

Moreover, it is well known that retail prices tend to increase faster than wholesale prices, especially in the case of necessities. The prices of necessities, for which demand is generally price-sensitive, also generally reflect the poor bargaining power of the consumer vis-À-vis the seller. The spiralling retail price of wheat in the North Indian markets is a classic example of this situation, where the consumer takes what he is given by the retailer. It is also well known that retail prices are generally “sticky downward.” They do not fall even if they are supposed to, for instance, following a lowering of taxes.

The problems associated with using the WPI as a measure of inflation are further compounded by the fact that the index does not include prices of services that have an important bearing on the actual cost of living. This is a particularly serious problem in the context of economic liberalisation, which has forced large sections of the people to increasingly depend on services such as medical care, education, transport, telecommunication, municipal services, and even water and electricity from private sources.

Data from surveys conducted in 2004 by the National Sample Survey Organisation (NSSO) show that even poor rural households spend an increasing proportion of their incomes on private sources of health care. Another survey conducted a year later found that “cereal consumption per person per month has declined from 13.4 kg to 12.1 kg [by nearly 10 per cent] between 1993-94 and 2004-05 in rural India and from 10.6 kg to 9.9 kg in urban India [by 6-7 per cent].” The data are ominous pointers to how the poor are tightening their belts to cope with price inflation. They also indicate how they are rebalancing their family budgets in order to deal with a situation that has increasingly been pushing them towards the market.

The only reason why the WPI is still being used, despite its failure to capture the reality of what inflation actually means to large sections of people, is apparently because it is available sooner than any of the other indices. For instance, while the latest WPI data pertain to April 19 , the Consumer Price Index for Industrial Workers (CPIIW) refers to prices prevailing in February 2008.

Although there are four other major indices apart from the WPI — CPIIW, the CPI for Agricultural Labourers (CPIAL), the Consumer Price Index for Rural Workers (CPIRW), and the CPI for Urban Non-Manual Employees (CPIUNME) — the relevance of each of these indices has been questioned. These reservations have basically to do with the relevance of the weighting diagram used to construct the index.

The general tendency to concentrate on average prices can result in meaningless conclusions. It ignores variations in society as well as inflation’s geographical variance. Prices do vary across the country and this is not entirely accounted for by the cost of transportation. For instance, the latest release of the CPIUNME — popularly known as the ‘middle class price index’ — shows that the average annual rate of inflation for the country in March 2008 was 6 per cent. But in Bangalore it was 7.4 per cent. In Gulbarga, about 600 km away, prices for this section increased at an annual rate of over 12 per cent.

It is not as if the problems are confined to the Wholesale Price Index. There are also serious problems with the other cost of living indices. The problems are compounded by the fact that these indices are used for measuring real incomes of several important segments of the working population. For instance, the Consumer Price Index for Agricultural Labourers is used as an indirect measure of estimating the extent of poverty in rural India.

The CPI for Industrial Workers not only serves as the basis for the extent of Dearness Allowance payments to blue collar workers in the manufacturing sector but is also used as the yardstick for fixing wages for government employees, apart from workers in service industries such as banking and insurance. The problems of the cost of living indices essentially relate to the manner in which the relative weights have either been arranged or left unarranged in order realistically to reflect the actual consumption basket of the relevant social groups. For instance, trade unions such as the Centre of Indian Trade Unions (CITU) have serious reservations about the CPIIW, which was revised in 2006 with 2001 being the new base year for the index.

The CITU has pointed out that the rearranged index covers only workers from segments of industry while ignoring a large chunk of the workforce, particularly those employed in services. Workers’ unions have also complained that the rebalanced index assigns higher weights to consumer durables, while assigning inadequate weights to a range of services such as medical care, education and transport, whose prices have increased significantly in the last decade.

The CITU, in a complaint filed at the International Labour Organisation in 2006, pointed out that the shops from where prices were collected “were non-existent” and that “some had only a signboard without any materials.” It contended that the quality of material in several ration shops from which price data were being gathered was “so poor that workers were not purchasing from these shops.” It alleged that there were shops that stocked certain items just to serve the purpose of compiling the index and that no worker bought them.

While the WPI is an inappropriate measure of inflation in terms of its impact on the person on the street, the cost of living indices are no longer realistic because they do not reflect changing consumption patterns. For instance, the weights of the basket used for computing the CPIAL have remained unchanged for over 25 years. This outdated index continues to be used to measure the extent of poverty, apart from fixing minimum wages for agricultural workers.

Inflation’s differential impact has serious consequences for equity. It may result in some sections being better off than others. If, as is the case now, the relative prices of commodities, notably foodgrains, that are vital for the poor are rising faster than the prices of articles bought by the rich, a shift in the distribution of wealth in society is under way.

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