Inflation Decoded: Measurement, Impact & Policy in India

Introduction to Inflation

Inflation refers to a sustained increase in the general price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money.

Measuring inflation accurately is crucial for economic policymaking, especially for central banks like the Reserve Bank of India (RBI) in its role of maintaining price stability. The impact of inflation is widespread, affecting individuals, businesses, and the overall economy.

This document delves into the various indices used to measure inflation in India, their nuances, the impact of inflation, and related policy considerations.

4.2.1. Wholesale Price Index (WPI)

Definition & Scope

The Wholesale Price Index (WPI) measures the average change in prices of goods sold in bulk by wholesale businesses to other businesses. It tracks prices at the first point of bulk sale in the domestic market. (Source: Office of Economic Adviser, DPIIT)

Primarily covers goods only and does not include services.

Components & Base Year

The WPI basket is divided into three major groups:

Primary Articles (Weight: 22.62%): Food articles (cereals, paddy, wheat, pulses, vegetables, fruits, milk, eggs, meat, fish etc.), non-food articles (oilseeds, minerals, crude petroleum).
Fuel & Power (Weight: 13.15%): LPG, petrol, diesel, electricity.
Manufactured Products (Weight: 64.23%): Largest component. Includes textiles, apparel, paper, chemicals, plastics, cement, basic metals, fabricated metal products, machinery, transport equipment etc.

Base Year: The current base year for WPI is 2011-12. (Revised in May 2017 from 2004-05).

Limitations of WPI

Does not capture price changes at the consumer level.
Excludes services, which form a significant part of the economy.
Prices may not be actual transaction prices but quoted prices.
Some items included (like crude oil, minerals) are inputs and not directly consumed, leading to a cascading effect representation which can be misleading for final inflation.

Uses of WPI

Monitoring wholesale price movements and an indicator of supply-demand dynamics in industry, manufacturing, and construction.
Used by the government for policy formulation related to trade, fiscal, and other economic policies.
Used for escalating contract prices for raw materials, machinery etc.

Institutional Framework

Published by the Office of Economic Adviser (OEA), Department for Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce & Industry.
Data is released on a monthly basis (around the 14th of every month).

4.2.2. Consumer Price Index (CPI)

Definition & Scope

The Consumer Price Index (CPI) measures the average change in prices paid by ultimate consumers for a basket of consumer goods and services over time. It reflects the cost of living for a typical household. (Source: NSO, MOSPI)

Covers both goods and services, reflecting the actual inflation faced by consumers.

Types of CPI:

CPI for Industrial Workers (CPI-IW)

Base Year: 2016 (revised from 2001 in October 2020).
Compiled by: Labour Bureau, Ministry of Labour and Employment.
Uses: To regulate dearness allowance (DA) for government employees and industrial workers.

CPI for Agricultural Labourers (CPI-AL)

Base Year: 1986-87.
Compiled by: Labour Bureau.
Uses: To revise minimum wages for agricultural labor.

CPI for Rural Labourers (CPI-RL)

Base Year: 1986-87.
Compiled by: Labour Bureau.
Uses: Broader than CPI-AL, used for wage fixation in rural areas.

CPI-Urban (CPI-U)

Base Year: 2012.
Compiled by: National Statistical Office (NSO), Ministry of Statistics and Programme Implementation (MOSPI).

CPI-Rural (CPI-R)

Base Year: 2012.
Compiled by: NSO, MOSPI.

CPI-Combined (CPI-C)

This is the headline CPI figure for India, calculated by giving appropriate weights to CPI-Urban and CPI-Rural.
Base Year: 2012.
Compiled by: NSO, MOSPI.
Significance: Adopted by the Reserve Bank of India (RBI) as the primary anchor for monetary policy under the flexible inflation targeting framework since 2014 (Urjit Patel Committee recommendation).
Data is released on a monthly basis (around the 12th of every month).

Components (approx. weights for CPI-Combined):

Food and Beverages: ~45.86% (High weightage makes Indian CPI very sensitive to food price shocks)
Fuel and Light: ~6.84%
Housing (urban only, imputed for rural): ~10.07%
Clothing and Footwear: ~6.53%
Pan, tobacco, and intoxicants: ~2.38%
Miscellaneous (education, health, transport, recreation etc.): ~28.32%

4.2.3. Differences & Relationship: WPI vs. CPI

Feature	Wholesale Price Index (WPI)	Consumer Price Index (CPI)
Commodities	Goods only	Goods and Services
Prices Paid By	Producers/Wholesalers at the factory/mandi level	Final Consumers at the retail level
Purpose	Tracks inflation at wholesale/producer stage	Tracks inflation at consumer level / Cost of Living
Compiler	Office of Economic Adviser (OEA), Ministry of Commerce & Industry	NSO (for CPI-U, R, Combined); Labour Bureau (for CPI-IW, AL, RL)
Primary User for Policy	Historically used, now less for monetary policy. Still relevant for industrial policy.	RBI for monetary policy (CPI-Combined)
Basket Coverage	Focus on producer goods, raw materials, intermediate goods	Focus on consumer goods and services (food, housing, transport, health etc.)
Weightage	Highest weight to Manufactured Products (64.23%)	Highest weight to Food and Beverages (~45.86%)
Volatility	Can be more volatile due to global commodity prices (e.g., crude oil). Less affected by service price stickiness.	Can be volatile due to food prices (especially perishables). Services prices tend to be stickier.
Indirect Taxes	Excludes indirect taxes (prices are ex-factory)	Includes indirect taxes (prices are at the retail level)

Relationship: Changes in WPI often precede changes in CPI, acting as a leading indicator. However, the divergence can be significant due to different commodity baskets, weightages, and the inclusion of services in CPI.

For instance, a rise in global crude oil prices will reflect more immediately and significantly in WPI (Fuel & Power) than in CPI, though it eventually passes through to consumer transport and other costs.

4.2.4. Producer Price Index (PPI)

Concept of PPI

The Producer Price Index (PPI) measures the average change in selling prices received by domestic producers for their output. It measures price changes from the perspective of the seller, unlike WPI which measures prices from the perspective of the buyer at the wholesale level.

PPIs usually measure prices for goods as they leave the factory gate (ex-factory prices) or at the point of production for services.
PPI does not include indirect taxes but includes subsidies if they affect the producer's realization. This helps in understanding the pure price trends for producers.
Most developed countries have transitioned from WPI to PPI.

Potential for Future Use in India

The B.N. Goldar Committee (2014) recommended replacing WPI with PPI. The government accepted this recommendation in principle.
Advantages over WPI:
- Provides a more accurate measure of price pressures faced by producers.
- Better alignment with international practices, facilitating cross-country comparisons.
- Can provide detailed sectoral inflation data valuable for policy and business decisions.
- Avoids the problem of "double counting" inherent in WPI (where an item can be both an input and an output).
Current Status: The government has been working on developing a PPI for India. Test PPIs have been compiled for some sectors. Full-fledged implementation is awaited. (Source: Economic Survey, various years)

4.2.5. Impact of Inflation

Inflation has multifaceted impacts on different sections of society and various economic activities:

On different sections of society

Savers: Hurt, as real value of savings erodes if interest rate < inflation rate.
Borrowers: Benefit, as real value of repayment decreases (especially fixed rates).
Fixed Income Earners: Hurt (pensioners, salaried with fixed pay) as purchasing power declines.
Producers/Entrepreneurs: May benefit short-run if output prices > input costs. High uncertainty hurts planning.
Exporters: Hurt if domestic inflation > competitor countries, making goods less competitive.
Importers: Imports may become cheaper relative to domestic goods, potentially increasing trade deficit.
Government: Benefits as borrower (reduced real value of debt). Tax revenues may increase. Expenditure also increases.

On Economic Activities

Investment: High and volatile inflation creates uncertainty, discouraging long-term investment.
Consumption: Mild inflation might encourage current consumption. High inflation erodes purchasing power, reducing overall consumption.
Income Distribution: Can worsen inequality. Poor suffer more; asset-holders may benefit.
Exchange Rates: Higher domestic inflation relative to other countries can lead to domestic currency depreciation.

Phillips Curve

Concept: Proposed by A.W. Phillips, suggests a stable and inverse relationship between inflation and unemployment in the short run. Lower unemployment is associated with higher inflation, and vice-versa.
Rationale: As aggregate demand increases, businesses hire more workers (reducing unemployment), leading to wage pressures and higher prices (inflation).
Short-run vs. Long-run:
- Short-run: Trade-off generally holds.
- Long-run: Trade-off disappears. Long-run Phillips Curve is vertical at the Natural Rate of Unemployment (NRU) or Non-Accelerating Inflation Rate of Unemployment (NAIRU) as people adjust expectations.
Stagflation: Situation where both inflation and unemployment are high, challenging the traditional Phillips Curve relationship (e.g., oil shocks of the 1970s).
Relevance in India: Relationship complex due to supply-side shocks, structural rigidities, large informal sector. (Source: RBI publications).

Unemployment Rate (%)

Inflation Rate (%)

Prelims-ready Notes

                         WPI Highlights
                        Measures: Wholesale prices of goods only.
Base Year: 2011-12.
Publisher: OEA, DPIIT, Ministry of Commerce & Industry.
Frequency: Monthly.
Major Components (Weight): Manufactured Products (64.23%) > Primary Articles (22.62%) > Fuel & Power (13.15%).

                    

                         CPI-Combined Highlights
                        Measures: Retail prices of goods and services.
Base Year: 2012.
Publisher: NSO, MOSPI.
Frequency: Monthly.
RBI's official inflation measure for monetary policy.
Major Components (Weight approx.): Food & Beverages (45.86%) > Miscellaneous (28.32%).

                    

                         Other Key Points
                        Other CPIs: CPI-IW (Base 2016, Labour Bureau, DA calc); CPI-AL/RL (Base 1986-87, Labour Bureau, rural wage revision).
PPI: Proposed to replace WPI (Goldar Committee). Measures producer price, ex-factory, excludes indirect taxes.
Impact of Inflation: Benefits: Borrowers, producers (short-run). Harms: Savers, fixed-income earners, lenders.
Phillips Curve: Short-run inverse relation (inflation & unemployment). Long-run: Vertical at NAIRU.

                    

Summary Table: WPI vs CPI-Combined

Feature	WPI	CPI-Combined
Focus	Wholesale prices	Retail prices (Cost of Living)
Items	Goods only	Goods & Services
Base Year	2011-12	2012
Publisher	OEA, Min. of Commerce & Industry	NSO, MOSPI
Highest Weight	Manufactured Products	Food & Beverages
Policy Anchor	Less for monetary policy, more for industry	RBI's primary for monetary policy

Mains-ready Analytical Notes

Debates/Discussions

WPI vs. CPI as an Inflation Indicator:

WPI: Traditionally used. Reflects producer-side. Criticized for not reflecting consumer burden, excluding services, double counting.
CPI: Better reflects consumer cost of living, includes services. RBI's shift to CPI-Combined (Urjit Patel Committee, 2014) aligns India with global best practices.
Divergence: WPI and CPI often differ due to varying baskets, weights, price collection. E.g., high food inflation: CPI higher. Global commodity spikes: WPI higher.

Headline vs. Core Inflation:

Headline: Overall inflation, includes volatile food/fuel (e.g., CPI-Combined).
Core: Excludes food/fuel. Better indicator of underlying pressures. RBI monitors closely for second-round effects.

Challenges in Inflation Measurement:

Data Collection: Quality and timeliness issues.
Weight Revisions: Crucial but resource-intensive, as consumption patterns change.
Substitution Bias: CPI assumes fixed basket; consumers substitute away from high-priced goods.
Quality Adjustments: Difficult to adjust for product quality improvements.

Historical/Long-term Trends, Continuity & Changes

Historically, India focused on WPI. Shift to CPI for monetary policy is a major change.
Food inflation has persistently been a challenge due to supply-side bottlenecks, monsoon dependence, inefficient supply chains.
RBI adopted flexible inflation targeting (2016, RBI Act amendment): 4% CPI inflation (+/- 2% tolerance band). Provides nominal anchor.

Contemporary Relevance/Significance/Impact

Monetary Policy: Key determinant of RBI's stance (repo rate adjustments). High inflation prompts tightening.
Fiscal Policy: Government uses measures (tax cuts, subsidies, duties) to manage supply-side inflation. High inflation can strain finances.
Welfare: Directly impacts household budgets and living standards, especially for poor/vulnerable.
Economic Growth: High and volatile inflation is harmful to sustainable growth; creates uncertainty, distorts resource allocation.

Real-world/Data-backed Recent Examples

Post-Pandemic Inflation (2021-2023): Global supply chain disruptions, rising energy/commodity prices (Russia-Ukraine), pent-up demand led to surge. CPI inflation breached RBI's 6% limit.
Food Inflation: Vegetable prices (tomatoes, onions) frequently cause CPI spikes due to weather/pest issues (e.g., Tomato surge mid-2023).
RBI's Response: Raised repo rate significantly from May 2022 to Feb 2023 to combat inflation.

Integration of Value-added Points

Price Stabilization Fund (PSF): Dept. of Consumer Affairs scheme to tackle price volatility of agri-horticultural commodities (onions, potatoes, pulses) via procurement/buffer stocking.
Measures to control inflation (Recent examples): Export restrictions (wheat, rice, sugar), duty cuts (edible oils, pulses), release of buffer stocks, Open Market Sale Scheme (OMSS) by FCI, stock limits (wheat).
GDP Deflator: Another measure of inflation: (Nominal GDP / Real GDP) * 100. Comprehensive, but available with lag, not used for short-term policy.

Current Affairs and Recent Developments (Last 1 Year)

Persistent High Food Inflation

Throughout 2023 and early 2024, food inflation, particularly in cereals, pulses, and vegetables, remained a concern, keeping headline CPI elevated. For example, CPI inflation stood at 5.09% in February 2024, with food inflation at 8.66%. (Source: MoSPI Press Release, March 2024).

RBI's Monetary Policy Stance

The RBI Monetary Policy Committee (MPC) has maintained a pause on repo rates since February 2023 (repo rate at 6.5%) but has reiterated its commitment to bringing inflation down to the 4% target, focusing on "withdrawal of accommodation." (Source: RBI MPC Resolutions).

WPI Inflation Trends

WPI inflation was in negative territory for several months in mid-2023 due to a high base effect and fall in global commodity prices, but turned positive towards the end of 2023 and stood at 0.20% in February 2024. The divergence between WPI and CPI has been notable. (Source: Office of Economic Adviser).

Government Interventions

Continued export restrictions on wheat and certain categories of rice.
Actively used OMSS to offload wheat and rice to cool market prices.
Imposed stock limits on wheat for traders, wholesalers, retailers, processors (June 2023).
Pushing for diversification of edible oil sources and increasing domestic production.

Discussions on Base Year Revision & Geopolitical Events

Government is considering revising base years for CPI and IIP. Steering Committee formed. CPI-AL/RL base year revision also overdue.
Geopolitical Events: Red Sea crisis raises concerns about shipping costs and supply chains impacting inflation.

UPSC Previous Year Questions (PYQs)

Prelims MCQs

1. Consider the following statements: (UPSC Prelims 2020)

The weightage of food in Consumer Price Index (CPI) is higher than that in Wholesale Price Index (WPI).
The WPI does not capture changes in the prices of services, which CPI does.
Reserve Bank of India has now adopted WPI as its key measure of inflation and to decide on changing the key policy rates.

Which of the statements given above is/are correct?

(a) 1 and 2 only
(b) 2 only
(c) 3 only
(d) 1, 2 and 3

Answer: (a)

Explanation: Statement 1 is correct. Statement 2 is correct. Statement 3 is incorrect (RBI uses CPI-Combined).

2. Inflation benefits the debtors. (UPSC Prelims 1998)

This is because:

(a) debtors pay less in real terms
(b) debtors pay more in real terms
(c) creditors get more in real terms
(d) None of the above

Answer: (a)

Explanation: Inflation reduces the real value of money. So, debtors repay loans with money that has less purchasing power than when they borrowed it.

Mains Questions

1. Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments. (UPSC Mains 2019)

Direction:

Discuss the relationship between GDP growth, inflation, and overall economic health.

Value Points:

Acknowledge the premise: good growth and low inflation are generally positive.
Define "good shape": macroeconomic stability, fiscal health, employment, external sector balance.
Arguments for "good shape": Stable inflation (within RBI target) boosts investor confidence, protects purchasing power. Steady GDP growth creates jobs, increases income.
Counter-arguments/Nuances: Question if growth is inclusive, quality of employment, sustainability, impact of inflation on different sections, underlying structural issues. Cite relevant data.
Conclude with a balanced view, highlighting achievements and challenges.

2. What is the Monetary Policy Committee (MPC) of India? Explain its role in controlling inflation in the country. (UPSC Mains 2017)

Direction:

Explain the composition and mandate of MPC and its tools for inflation control.

Value Points:

Composition of MPC (6 members: 3 RBI, 3 Govt. nominees).
Mandate: Maintain price stability while keeping in mind growth.
Inflation Target: Flexible Inflation Targeting (4% +/- 2% CPI-Combined).
Tools: Repo rate, reverse repo rate, MSF, CRR, SLR, OMOs, communication/forward guidance.
Mechanism: How policy rate changes impact liquidity, credit cost, demand, and inflation.
Successes and challenges faced by MPC.

Trend Analysis (Last 10 Years)

Prelims Trends

Initially, more factual: publisher, base years, components, basic differences.
Recent years: More conceptual/application-based. Implications of WPI vs. CPI, impact of inflation on groups, Phillips Curve understanding, core vs. headline inflation.
Tendency to link concepts with current economic scenarios/policy shifts.

Mains Trends

Direct definitions rare. Focus on analytical aspects: causes, impact, policy responses (monetary/fiscal).
Role of RBI/MPC. Debate WPI vs. CPI, rationale for CPI as anchor.
Relationship between inflation, growth, unemployment.
Linking inflation to broader themes: inclusive growth, economic stability, recent government policies.
Increasing emphasis on contemporary issues and data-backed arguments.

Original Questions

Original MCQs for Prelims

1. Consider the following statements regarding price indices in India:

The Producer Price Index (PPI), if implemented, would measure price changes from the perspective of the seller, excluding indirect taxes.
The Consumer Price Index (CPI-Combined) gives the highest weightage to the 'Miscellaneous' group, which includes services like education and health.
A revision in the base year of a price index is primarily done to reflect changes in production patterns and not consumption patterns.

Which of the statements given above is/are correct?

(a) 1 only
(b) 1 and 2 only
(c) 2 and 3 only
(d) 1, 2 and 3

Answer: (a)

Explanation: Statement 1 is correct. Statement 2 is incorrect (Food & Beverages has highest weight). Statement 3 is incorrect (Base year revisions reflect changes in both production and consumption patterns).

2. Which of the following best describes the concept of "NAIRU" (Non-Accelerating Inflation Rate of Unemployment)?

(a) The rate of unemployment at which inflation is zero.
(b) The rate of unemployment consistent with a stable rate of inflation.
(c) The minimum rate of unemployment achievable without causing deflation.
(d) The rate of unemployment that exists only during periods of economic recession.

Answer: (b)

Explanation: NAIRU represents the lowest level of unemployment an economy can sustain without causing inflation to rise. It corresponds to the long-run vertical Phillips Curve.

Original Descriptive Questions for Mains

1. "While the shift from WPI to CPI as the primary inflation anchor by the RBI was a welcome move, managing inflation in India continues to be complex due to its structural specificities." Critically analyze this statement, highlighting the challenges and suggesting policy measures.

Key Points/Structure:

Introduction: Rationale for RBI's CPI shift.
Merits of CPI as Anchor: Household inflation, services inclusion, global practice.
Structural Challenges in India: High food weight, fuel price shocks, supply-side bottlenecks, informal economy, administered prices, expectation formation.
Policy Measures: Agricultural reforms, supply chain strengthening, fiscal prudence, trade policy, infrastructure investment, data quality.
Conclusion: Emphasize complexity and multi-pronged strategy.

2. Discuss the differential impact of sustained high inflation on various stakeholders in the Indian economy. How can policymakers mitigate the adverse effects, particularly on vulnerable sections?

Key Points/Structure:

Introduction: Define high inflation, negative connotations.
Differential Impact: Savers/Lenders (negative), Borrowers (positive), Fixed Income (negative), Wage Earners (mixed), Producers (mixed), Government (mixed), Exporters/Importers (negative).
Adverse Effects on Vulnerable: Disproportionate impact on poor (food items), savings erosion, increased indebtedness, health/nutrition.
Mitigation Measures: Monetary policy (RBI targeting), Fiscal policy (targeted subsidies, PDS, taxation), Supply-side (PSF, buffer stocking), Social Safety Nets (MGNREGA), Financial Inclusion.
Conclusion: Importance of price stability for inclusive growth and targeted interventions.

Conclusion & Way Forward

Accurate measurement and effective management of inflation are paramount for macroeconomic stability and inclusive economic growth. India has made significant strides by adopting CPI-Combined as its key inflation metric for monetary policy, aligning with global standards. However, challenges persist, particularly due to supply-side factors, food price volatility, and external shocks.

Way Forward:

Strengthening Data Systems: Continuous improvement in data collection for price indices and timely revision of base years and weights.
Adoption of PPI: Expediting the full-fledged adoption of the Producer Price Index (PPI) to get a clearer picture of producer-side inflation.
Supply-Side Reforms: Addressing structural bottlenecks in agriculture, energy, and manufacturing to ensure stable supply and mitigate cost-push inflation.
Coordinated Policy: Enhanced coordination between monetary and fiscal authorities.
Managing Expectations: Clear communication by the central bank to anchor inflation expectations.

Significance:

Maintaining moderate and stable inflation is crucial for:

Protecting the purchasing power of households, especially vulnerable sections.
Encouraging savings and investment by reducing uncertainty.
Ensuring competitiveness of Indian exports.
Fostering sustainable economic growth and development.

Effective inflation management, therefore, remains a cornerstone of India's economic policy framework, directly impacting the welfare of its citizens and the long-term trajectory of the economy.