How is Inflation calculated in India?

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Inflation as we know it is one of the most important macro indicators tracked by economists, central banks and even the stock markets worldwide. It measures the general rise in the price level of goods & services in the economy. Persistently high inflation can have severe ramification on the economy as it decreases purchasing power, weakens currency, and unemployment & interest rises. On the contrary, deflation (where prices of goods & services are consistently going south) can also be bad for the economy.

Therefore, inflation is like a double-edged sword wherein a decent rate can spur growth, boost employment however too much of it can be detrimental for the economy. For India, past evidence suggests that inflation of around 4% is healthy for the economy and can spur growth and boost employment. Therefore, the government has mandated the RBI to maintain inflation at 4% with a tolerance level of +2/-2%. 

The inflation is calculated by two key indices i.e Wholesale Price Index and Consumer Price Index. The wholesale price index takes into account changes in the price of goods sold and traded in bulk by wholesale businesses to other businesses. The Consumer Price Index (CPI) is designed to measure the changes over time in general level of retail prices of selected goods and services that households purchase for the purpose of consumption. For the past many years, India used WPI to measure inflation. However, when Raghuram Rajan was at the helm at the RBI, he started using CPI to measure the inflation as it included goods & services that directly affected the common man.  

Currently, CPI is been widely used as a macroeconomic indicator of inflation, and also as a tool by the government and central bank for targeting inflation and monitoring price stability. It is also used as deflators in the National Accounts. The CPI data in India is released on a monthly basis (12th of every month at 5:30 pm by the government). The base year for the on-going CPI index is 2012.

How is CPI calculated?

The first step in compiling the CPI data is to classify, wherein items are organized into categories based on information on one or more characteristics inherent to the items. Some of the main categories include Food & Beverages, Pan, tobacco and intoxicants, Clothing & footwear, Housing, Fuel & Light and Miscellaneous (Household goods & services, Health, Transport & Communication, Recreation & Amusement, Education, Personal Care & effects). Each item is assigned a specific weight which is derived on the basis of average monthly consumer expenditure of an urban/rural household obtained from the Consumer Expenditure Survey (2011-12). The weights (Table below) are different for rural and urban areas as the expenditure patterns is different for both.

Cereals and products12.46.69.7
Meat and fish4.42.73.6
Milk and products7.75.36.6
Oils and fats4.22.83.6
Pulses and products31.72.4
Sugar and Confectionery1.711.4
Non-alcoholic beverages1.41.11.3
Prepared meals, snacks, sweets etc5.65.55.6
Food and beverages54.236.345.9
Pan, tobacco and intoxicants3.31.42.4
Clothing and footwear7.45.66.5
Fuel and light7.95.66.8
Household goods and services3.83.93.8
Transport and communication7.69.78.6
Recreation and amusement1.421.7
Personal care and effects4.33.53.9

The prices are collected (monthly) from both rural & urban from nearly 1,181 village markets covering all districts and 1,114 urban markets distributed over 310 towns of the country. The data provided in the survey is uploaded to a web portal for both rural as well as urban areas. Then using statistical methods, the numbers are compiled and a particular value for the index is released. The value of the index is compared to the corresponding period last year and the difference in percentage terms is the inflation rate for that month.

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