• News
  • Columns
  • Interviews
  • BW Communities
  • BW TV
  • Subscribe to Print
BW Businessworld

Pick A Number

Photo Credit :

And he is not alone. A survey of inflation numbers — and of inflationary expectations — in the media shows a dizzying array: wholesale price indices (WPI), consumer price indices (CPI), sectoral price indices, indices for specific commodities like oil, and several others. So, which inflation numbers do you use? The data underlying the inflation index numbers are a key input into that process, and so is their reliability and frequency of availability. In today’s context, and given approaching elections, the person who called inflation the long run consequence of short-term expediencies may not have been far off the mark.
For us as consumers, the CPI that includes price changes of products we use on a daily basis matters most; it determines how much we will pay for goods and services, how it affects the cost of doing business, and can create havoc with personal and corporate investment. Landlords take CPI into account in setting rental contracts, and inflationary expectations set labour contracts and government fiscal policy.
The WPI is, in fact, a family of indices: you could theoretically break it down into three progressive stages: crude goods (commodities such as foodgrains and metals), intermediate goods (textiles, steel, cement) and finished goods (edible oils, cars and refrigerators). Because the WPI is available week on week with a lag of about a fortnight, it is the most watched inflation index of all. The government uses the WPI for policy-making purposes.
Computing a single inflation measure poses stiff challenges. For example, services account for nearly 60 per cent of GDP, but do not figure in the indices at all. A Reserve Bank of India (RBI) committee set up to review the various indices — and perhaps come up with a harmonised index of consumer prices — suggested that a separate services price index be constructed.

Related Stories

Net Worth Of Wealth Lists

It's Time To Bond

Click here for more BW Columns

Despite all that, it’s hard to know the real level of inflation in the economy. For instance, there have been rather sudden price changes in certain components of the WPI; the index of metal prices moved sharply, after having moved rather steadily since September 2007. Supply side factors, such as currency markets and the commodity cycle upturn, also contribute to inflation. Consumer demand — fuelled in part by tax cuts announced in the Budget, along with anticipated pay increases resulting from the recommendations of the Sixth Pay Commission — is also expected to push inflation upwards. In hindsight, the RBI — as the agency responsible for inflation management — may have been on the ball when it came to assessing the real levels of inflation out there.
Now, as other central banks cut rates to deal with the crisis in global credit markets, the RBI following suit might be precarious. Before now, capital and financial markets anticipated the RBI to maintain inflationary expectations at the lower end of the policy rate corridor between its repo and reverse repo rates (the rates at which the RBI pumps in liquidity by buying securities and banks park their excess liquidity with the central bank by buying securities, respectively).
Rather than use interest rates to manage those expectations, the RBI chose to use liquidity management — reducing excessive money supply through market stabilisation scheme (MSS) bonds, increasing reserve requirements by raising the cash reserve ratio (CRR), and open market operations through its liquidity adjustment facility (LAF - the repo and reverse repos). Note that the RBI has elegantly distributed the costs accordingly: to the government (via the MSS), the banks (via CRR increases) and itself (through the LAF). RBI Governor Y. V. Reddy had made this strategy plain in his October 2007 monetary policy review, if only anyone was listening.
Will the RBI change its stance now? Not very likely. Capital market players have paid an ‘uncertainty premium’ — for misunderstanding which end of the corridor the RBI will operate — and bet incorrectly before. All signals point to the RBI using liquidity management to maintain interest rates at the upper end of the corridor. Will the markets learn this time?
(Businessworld issue 22-28 April 2008)