Inflation can be defined as a general increase in price level of goods and services in an economy. One time increase in prices of goods and services is not inflation. For inflation to be present, the rise in prices of goods and services has to be persistent. Inflation reduces the purchasing power of the currency and if allowed to go up too much, it can destroy the entire exchange rate mechanism of the country.
There are basically two methods to calculate inflation:-
- Wholesale Price Index (WPI)
- Consumer Price Index (CPI)
Most of the countries in the world use CPI to measure inflation. CPI tracks the prices of goods and services purchased by the end consumers. India is probably the only country in the world which uses WPI as a measure of inflation. As the name suggests, WPI uses prices of goods and services purchased at the wholesale market. Thus, it does not give true measure of inflation. WPI in effect, underestimates the true inflation as prices at the wholesale level are inevitably lower than the one the consumer ultimately pays.
Apart from this, the WPI basket includes 430 odd commodities. Inclusion of too many data points makes the sample insignificant as some of the commodities might no longer be as important as it were from the consumption perspective. Further, the WPI basket is not frequently updated to reflect the changes in consumption patterns. The last time the basket was reviewed, was in 1993-94.
It’s high time that India uses the CPI measure to calculate inflation. The CPI basket is narrower than the WPI basket and includes the goods and services purchased by the end consumers. Thus, CPI is a true measure of inflation.
Why then is India not shifting to the CPI model? This is because there are quite a few hindrances towards a complete shift to the CPI model.
Notable ones include multiple CPI indices to choose from. For instance, there are various CPI indices like the CPI Industrial workers and the CPI Rural labor etc. Thus, shift to one particular index could be risky as it might completely ignore the price escalation in other areas. Further, the CPI numbers are reported on monthly basis. Thus, the information proves to be a laggard in terms of news flow.
WPI numbers are reported on a weekly basis and thus are of more relevance. Thus the use of WPI indicates that the inflation problem prevalent in India right now is much more severe than what the numbers reveal.