Mumbai:Two leading economists associated with the Multi-Commodity Exchange (MCX) have pointed to serious flaws in the present method of calculating inflation and called for a change in line with prevalent methodologies in developed economies.
In a research paper, economists V Shunmugam and D G Prasad have called for a shift in the model followed by developed countries where the Consumer Price Index (CPI) is used to calculate inflation.
Writing the paper in their personal capacity, the duo said: “CPI is the official barometer of inflation in many countries such as the US, UK, Japan, France, Canada, Singapore and China. The governments there review the commodity basket of CPI every 4-5 years to factor in changes in consumption pattern.”
In India, however, it is the Wholesale Price Index (WPI) which is calculated to decide the inflation rate in the economy.
MCX Chief Economist V Shanmugam told PTI here that there were 435 commodities included in the WPI, of which over 100 have ceased to be important from the consumption point of view.
“Some of the WPI commodities include coarse grains that go into making of livestock feed. But they continue to be considered while measuring inflation,” he said.
The WPI that was constituted in 1993-94 has virtually remained unchanged since then, he said, adding that in the present context, it has lost quite a bit of its relevance while calculating inflation.
There are 435 commodities in the WPI, of which over 100 have ceased to be important from the consumption point of view
The sole reason why many unimportant commodities continue to remain included is possibly because data on their prices was available, Shunmugam said, adding that “computation of such insignificant commodities in the index could distort the WPI that is arrived at.”
“Actually, WPI is supposed to measure impact of prices on business. But we use it to measure the impact on consumers. Many commodities not consumed by consumers get calculated in the index. And it does not factor in services which have assumed so much importance in the economy,” he said.
Policy-makers often track WPI as it indicates the price movement in advance before the commodities hit the retail market which helps them take required steps to smoothen prices at the retail level.
“Theoretically, it could be right but in one of our analysis, it was not found so,” the duo said.
For instance, the effect of price movement in crude oil on WPI and CPI was felt at around the same time. But, the volatility of WPI is 0.55 per cent while that of CPI is 0.82 per cent, they said.
This indicates that CPI deserves sharper scrutiny than the WPI to assess the impact of inflation on the common man.
However, shifting from WPI to CPI model is “not easy” Shunmugam averred.
He said: “Our CPI is good as it considers prices of housing, entertainment, education, etc but its collection takes a long time and by the time the data is collated, it is two months old.”
With the index needing to be as up-to-date as possible, “a lag of (only) one or two weeks could be acceptable,” he said.
Given the vast size of the country and diversity, the variations in prices and multiplicity of taxes in different regions would have to be factored in, he said, which would call for “great efforts.”
The cost of collecting such data would also be high, he added.
But given that developed countries have been successfully following the CPI model over the years, India too should consider switching to this model, he advocated.
Another entity has also questioned the validity of WPI as the basis for computing inflation.
Brokerage house First Global in a paper for its investors and clients, has raised the same issue recently.
In a chapter titled “Is WPI an accurate measure of inflation at all?” First Global has enumerated several shortcomings of the index.
Referring to the non-inclusion of services in WPI, it said: “This is a very serious omission as services currently contribute around 55 per cent of the country’s GDP.”
“Thus, the largest and fastest growing segment of GDP stands excluded from inflation measurement,” it said.