Inflation:What lies beyond the figures!

In a layman's language inflation is a situation arising out of too much money chasing too few goods, leading to a rise in price level. Runaway inflation is detrimental for the consumers, especially the weaker sections of the society. The dilemma before the Govt/RBI is to strike a balance between growth and inflation. The frequent increases in CRR and REPO rates leads to hardening of interest rates across the board, which is detrimental for the producers leading to a slowing down of economic activity. If this situation continues for long, ultimately the consumers will have to bear the cost of the economic slowdown.

How far are our monetary authorities justified in sacrificing growth for the sake of controlling inflation, can be gauged by looking beneath the inflation figures released on a weekly basis. There are two kinds of inflation indeces in use in India: i) Wholesale Price Index (WPI), released on a weekly basis by the Ministry of Industry. ii) Consumer Price Index (CPI), declared on a monthly basis by the Ministry of Statistics and Programme implementaion (MoSPI). The figures that capture the headlines are the figures for WPI, which has reached a level of 12.6% for the week ended 9th August 2008. The latest available figures for the CPI for June 2008 are 7.3%, a good 5% lower than the WPI. Why this huge difference? The composition of WPI is Primary articles (22%), Fuel, Power. Light etc (14%), and Manufactured products (64%). Primary articles account for more than 50% weightage in the CPI. Another anomaly is in the calculation of point to point inflation. WPI shows the movement of prices on a Year on year (YOY) basis. A higher base effect reduces the figure while a lower base effect inflates the WPI. This is exactly what has been responsible for the unprecedented rise in WPI since May 2008.

How far is the Govt. responsible for this situation and what is the solution? The Govt. itself is to be blamed for the situation to a large extent. It cannot merely pass the entire blame of the rising prices on International commodity prices. The figures for WPI inflation are highly inflated because of the low base effect. In its endeavour to keep the inflation below the 5% level, Govt. kept the prices of petroleum products at depressed levels, even reducing the prices of petro products twice during the past year. It is now reflected in the higher WPI. Infact, in most of the countries CPI is considered to be a better representative of the price levels. MoSPI is in the process of revamping the CPI for Urban Workers, which is likely to replace the WPI as a broad measure of inflation by the middle of next year.

The International commodity prices including crude oil have started softening, therefore, there is little need for the RBI to pursue further tightening measures, which is likely to stifle growth rate.

Once the base effect blows over, WPI inflation will fall to single digits by the end of the year. The growth of Indian Economy remains intact despite the global slowdown. Investors with a long term perspective (minimum 12 months) can hold, even fresh buying can be initiated at lower levels.