Few Answers and Some More Questions!!!

Recently, I read a speech on ‘Statistics in the world of RBI’ by Mr. Duvvuri Subbarao, on the occasion of World Statistics Day, which answered quite a few of my queries related to inflation.

The report talks about Statistics in RBI’s Policy Making which includes (i) Quality of data; (ii) Data revisions; (iii) Data interpretation; and (iv) Data gaps.

This post is in three parts:
I. Questions with theirs answers from the report.
II. Additional Info gained
III. Questions which still need answers

I. My Questions answered
a. Why do we adopt a WPI based measure of inflation instead of CPI?

CPI (Consumer Price Index) would be a better indicator of the rise in prices due to demand side pressures. However RBI adopts a WPI system instead of CPI.

Below is the excerpt from the report:
The use of WPI as the headline inflation index is flawed, as it does not capture the final goods prices that consumers actually experience in the market. RBI should be guided more by the CPI, which more accurately reflects demand pressures because it is demand pressures that monetary policy action can influence.

Conceptually, the CPI is a better indicator of demand side pressures than the WPI. An increase in wholesale prices, if sustained, either results in an eventual increase in prices by retailers or a squeeze in their margins. If demand is strong, retailers may exercise pricing power and pass on the increase in wholesale prices to consumers. In case demand is weak, retailers will be forced to partly absorb the increase in wholesale prices in their margins. Thus, there is no denying that consumer prices better reflect demand side pressures than wholesale prices

Even so, in India, we have opted for WPI over CPI as a second best choice for a number of reasons. First and most importantly, we do not have a single CPI that is representative of the whole country. Until recently we had four, and of those, currently we have three CPIs representing different segments of the population. While WPI is computed on an all-India basis, CPIs are constructed for specific centres and then aggregated to an all-India index. Second, WPI is available with a slightly shorter lag than the CPIs. Third, WPI has a broader coverage than the CPIs in terms of the number of commodities, number of quotations, inclusion of non-agricultural products and tradeable items.

b. Which is the base year upon which the rate of inflation is calculated?

A. Excerpt from the report:
The revision of the basket for CPI series lags that of the WPI series. Last year, the WPI series was revised to the base of 2004-05 whereas the existing CPIs continue with the old base - for CPI-RL (1986-87), CPI-AL (1986-87) and CPI-IW (2001) which makes CPIs ill-equipped to capture the price behaviour caused by the rapid structural changes in the economy.

c. Which products are included in WPI index?

A. The Report doesn’t mention the details of the products included in the WPI, but gives some information about the class of the goods and the number of items included.

Excerpt:

The revision of the base year in the case of WPI also led to some increase in the weights towards fuel and power and manufactured products away from primary articles. Although changes in the weights for manufactured products were not substantial for the group as a whole, there has been a tilt in the weights towards non-food manufactured products reflecting changes in the production pattern over the decade. The number of commodities included in the new WPI series increased from 435 to 676, even after dropping/revising 176 items from the old series.

II. Additional Info gained:

1. Quality of Data:

The data on which the policies are made is not reliable. E.g. data on unemployment and wages show a certain paradox.
Certain statistics like for. E.g. the Index of Industrial Production (IIP) statistic shows counter- intuitive trends.
Excerpt.

During the period when the global financial crisis was at its peak - December 2008 to June 2009 - IIP growth was positive according to the then available IIP series. This was contrary to our assessment of the underlying trend of some deceleration on account of the crisis. The new IIP series, revised with 2004/05 as the base, now shows that IIP growth was, in fact, negative during that period vindicating our intuition. Again, the old IIP series indicated that industrial activity slowed in the second half of last year (2010/11) relative to the first half but the revised IIP series shows that industrial growth maintained roughly the same pace between the two halves of the fiscal year.

2. Data Revision:

The data on which the policies are based are not Real time.

Excerpt:
The Reserve Bank’s policy formulation is also handicapped by frequent revisions to data. We make policies in real time and if the provisional data that these are based on are inaccurate, the resultant policies can turn out to be sub-optimal choices. Take estimates of GDP growth. For the year 2009-10, for example, the Advance Estimate of GDP growth rate at market prices from the expenditure side, that came out in February 2010, was 6.8 per cent. That was changed to 7.7 per cent in the Revised Estimate in May 2010 and further to 9.1 per cent in the Quick Estimate in February 2011. Therefore, policy that per force had to use information on Advance Estimate of GDP was fraught with the risk of underestimating the growth momentum

3. The report also mentions about the exclusion of Service sector and the Price index in inflation calculation. It also mentioned need to monitor the Financial Stability especially after the recent economic crisis faced by the world.



III. Questions, which still need answers:


1. Is the high rate of inflation that we are facing currently influenced by increase in demand or lack of supply?

The monetary measures implemented by RBI would only curb the demand but what measures are being taken by the government to increase the supply? Have any import tariffs/ quotas eased?. Has there been any measure taken to discourage export of essential commodities? Has there been any measure taken to increase the production? As we have seen in the above report, the IIP figures are not completely reliable.

2. Our sentiment driven capital market is highly influenced by the RBI reports on inflation, IIP figures etc. Considering the accuracy of the data as mentioned in the report, where are we heading? Our markets either shoot up or crash based on such inaccurate data!!!

3. The world was facing a recession, then how were the prices increasing? How could inflation and recession co-exist? There were no hike in salaries stating the reason of recession and yet the prices kept increasing due to inflation. How can such two contradictory terms co- exist?

Last question:
4. Where are we heading?

The ever-increasing prices, their effect on the society at large and on the common man would require another post. The effect would be very similar to Abhimanyu’s chakravyu . There is no way out of this vicious circle.

The entire report by RBI can be accessed at the link provided below.


http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/SDASD060711.pdf