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A COMPARITATIVE ANALYSIS OF WHOLESALE PRICE INDEX AND CONSUMER PRICE INDEX IN THE INDIAN CONTEXT

Table of Content:

Sl no Chapter I

Particulars 1.1 Introduction to Indian Economy 1.2 introduction to WPI and CPI

Page no 2 4 9 9 9 9 9 9 10 12 22

Chapter II

Research Design 2.1 Title of the project report 2.2 Research Problem 2.3 Scope of the Study 2.4 Research Design 2.5 Objective of Study 2.6 Data collection Methodology 2.7 Limitations of the Study

Chapter III Chapter IV

Analysis Recommendations and Conclusions  Bibliography

CHAPTER I INTRODUCTION

India, a country which was world’s largest economy for more than 1500 years (though then it was geographically larger) and then was robbed by foreigners and yet the country with largest number of youths is determined to prove that India was a country of golden birds and it always will be.

GROSS DOMESTIC PRODUCT (GDP)
Sum of all goods and services produced in a country within a specific period is called GDP of the country. It is indicator of economic soundness of a country and parameter of mapping the living standers of the people, therefore the more is GDP the better is living standard. 2010 Q2 9.4% 2011 Q2 7.8%

Q1 7.3%

Q3 9.3%

Q4 8.9%

Q1 8.3%

Q3 7.7%

Q4 6.9%

6.9% GDP growth rate is the minimum in the previous two years. It is caused by high local borrowing costs and of course due to the euro crisis. In this quarter manufacturing industry’s growth dipped to 2.7 % from 7.2 % in previous quarter, however in order to address inflation, step taken by the reserve bank of India to increase key rates multiple time also hampered our industry badly. With the combined effect of rates hike and the euro crisis, industrial expansion became formidable.     $1.632 trillion (nominal: 9th; 2010) $4.057 trillion (PPP: 4th; 2010) GDP per capita $1371(nominal) GDP per capita $3408(ppp)

GDP by sector Service- 55.2% Industry- 26.3% Agriculture- 18.5%

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Consumer price Index In an economy, it is not possible that price of all goods and services will always be the same. It keeps changing and it badly affects a country’s purchasing power. The CPI is used to measure Inflation is our country. Food inflation in India has always been an issue to take care of. It seems it’s too difficult for the government to bring food inflation under control. By raising key rates the RBI is trying to cope with the situation. Food inflation in India is around 6.60 % on 8th dec 2011 from 12.30% on November 3 2011. Unemployment- 9.5% Export- 225.6 billion (US 12.6%) Import-357.7 billion (china 12.4%) FDI stock- 35.6 billion Revenue- 184 billion Expense- 270 billion Gross external debt- 238 billion (2008) Foreign reserves- 319 billions

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In today’s economic scenario there are constant changes and movement in prices. These changes greatly influence the buying and selling decisions of consumers, and thus the economic scenario. Thus, everyone including the government, businesses, producers and consumers want to keep a constant check on prices. However, given the large number of items that are sold and purchased every day, it is difficult to keep track it all. There are many indices based on prices in different markets, example Producer price index, Wholesale price index, Consumer price index etc. Of the many indices, two are of utmost importance. The first is the Wholesale Price Index (WPI) this is based on the price which is prevailing in the wholesale markets. The second one is the Consumer Price Index (CPI), which is based on the final prices of goods at the retail level. Both these indices are the weighted averages of prices of a specified set of goods and services. The use of price indices These indices are used for various purposes, some of the most important being forecasting in businesses, used by governmental and non-governmental organizations and institutions for their analysis, and by the RBI and the government of India to frame monetary and fiscal policy, etc. The WPI is the chief measurement index in India. In most other countries CPI is used as a chief index. The WPI in India is used to deflate national income and to calculate real output in the economy. Also we find that the exchange rates of Indian currency against the dollar are often adjusted on the basis of WPI What Is Wholesale Price Index (WPI)? Wholesale Price Index (WPI) is a price index which represents the wholesale prices of a basket of goods over time. In other words we can say that WPI is an indicator of price changes in the wholesale market. WPI measures the changes in the prices charged by manufacturers and wholesalers. WPI also measures the changes in commodity prices at a selected stages before goods reaches to the retail level; the prices may be those charged by manufacturers to wholesalers or by wholesalers to retailers or by some combination of these and other distributors. It is most importantly used to measure the inflation rate that the country is suffering, i.e. the change in the average price level of goods traded in wholesale market. It is usually released on a 4|Page

weekly basis (usually on Thursdays) to measure the change in the wholesale prices of a set of goods. This day of its release is very important as the stock prices generally tend to fall on that day given the declaration of inflation rate. The WPI is based on the prices of 435 commodities in India, which is an indicator of movement in prices of commodities in all trade and transactions. Advantages of WPI: 1. WPI has been in use in India since many years so the calculation is fairly easy. 2. It has over time developed and taken into its circle few of the important factors that need to be considered. 3. WPI measures inflation at each stage of production. 4. WPI is the basis for the economic deflation rate. Disadvantages of WPI: 1. WPI is said to give lots of erroneous results. 2. It ignores the service expenses etc which are more dominant expenses today. 3. It gives the view till the level of the wholesaler. India is a country with diverse consumer behaviour. It is hence not justified to use wholesale rate. 4. The true inflation rate in the economy is not disclosed. 5. There are a lot of insignificant goods that are considered in WPI like fodder given to cattle etc. These goods do not construe a high percentage of the income and expense today.

What Is Commodity Price Index (CPI)? Consumer Price Index (CPI) is a price index which represents the average price of a basket of goods over time. In other words, CPI is based on changes in prices at the retail level. CPI measures the average prices of goods and services which the consumers have paid for. Education, apparel, foods and beverages, communication, transportation, recreation, housing, and medical care are the 8 groups for which the CPI is set. Some services like school and government registration fees and electricity and water bills are also included sometimes.

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Advantages: 1. The CPI measures inflation only at final stage of production. 2. It is more reliable as compared to the WPI.

3. It includes the service sector etc which form a major part of expenses and income these days. 4. Unnecessary articles do not form a part of CPI. 5. The price prevailing in the lowest level is considered thus a true picture of inflation is given. Disadvantages: 1. The calculation of CPI is a very rigid task. It has a lot of information to be calculated. 2. Right now in India it is calculated by only a limited number of organizations the reliability of whose data is not guaranteed. 3. Some of the aspects covered under CPI are too difficult to account for. Differences between WPI and CPI: 1. WPI measures inflation at each stage of production. CPI on the other hand measures inflation only at final stage of production. 2. WPI is the major basis for the economic deflation rate, while CPI is the basis for the inflation rate. 3. WPI is the average of the sum of all the goods bought by the traders whereas CPIis the average of the sum of all the goods bought by consumers. 4. The WPI is compiled and published by Office of the Economic Advisor on a weekly basis while the CPI is compiled and published by the Labour Bureau on a monthly basis in India. 5. WPI is based on the price prevailing in the wholesale markets. While, CPI is based on the final prices of goods at the retail level. 6. There are only few countries that uses WPI to calculate inflation rates India being one of the biggest users whereas many developed and developing nations have already shifted to using CPI. 6|Page

7. WPI is said to have erroneous results while CPI will describe actual cost of living and inflation rate more accurately. It must be kept in mind the 100 percent accuracy is impossible to calculate. But, CPI is more reliable. 8. There are a lot of insignificant goods that are considered in WPI which have been discarded by CPI. 9. Services etc are ignored by WPI but are considered in calculating CPI.

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CHAPTER II Research Design

Title A Comparitative analysis of wholesale price index and consumer price index in the Indian context Statement of the problem While most of the developed and developing nations around the globe are using the Consumer Price Index, India is still using the age old method of calculating inflation using Wholesale Price Index. What are the reasons for the same? What should Indian politicians do? All of these construe a part of the research problem. Scope of the study The scope of the report includes the in depth analysis of both the price index and a justified out look to both. Objective    To study the structure Price Index used in India. To analyze alternative Price index. To compare and evaluate both the indices based on their reliability, accuracy and other tools. Research Methodology The analysis is based on the secondary data collected through internet, newpapers, magazines etc.

Data Collection Method   Primary sources : No primary sources have been used. Secondary sources : Secondary sources have been used to get the data. These secondary data consist of :a) Articles in news papers b) Text books articles

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Limitations of the study    It studies the application of Price indices only in the Indian context. We had a limited source of historical data to choose from. As CPI is not well followed in India, its precise implications cannot be evaluated.

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CHAPTER III ANALYSIS

Wholesale price index as stated earlier is basically an index which represents the wholesale price of a basket of goods over time. The official measure of inflation in the Indian economy is based on WPI and measures the general level of price changes at the level of either the wholesaler or the producer; and does not take into account retail margins. It is an index which indicates change in prices in the wholesale market. For calculation purposes the index is broadly divided into three sub-categories – Primary Articles, Fuel Products and Manufactured Products. This particular index does not cover non-commodity producing sectors viz. services and non-tradable commodities. The WPI status is released by the Economic Advisor to Commerce Ministry. Till the year 2009, WPI was released weekly with a lag of fortnight but now it is being released in two phases. While, Primary articles which include food items- like cereals,, non food itemsfiber, linseed and minerals- metallic minerals and fuel group inflation continue to be released weekly for its sensitivity with a fortnightly lag. The monthly inflation with Manufactured Products inflation is released also with a fortnight lag. It is calculated using 1993-94 as base and covers 447 commodities in all.

Why is India still following WPI?
In a country like India which is one of the highest when it comes to population and is known to be consumer oriented one does wonder why do we still follow a Wholesale price index which gives the wholesalers side of prices. Why do we not consider the Consumer price index which gives a clearer picture on the current inflation rate? The reasons are as follows: 1. The WPI is used to measure inflation in India since an appropriate CPI is not available. 2. The size of India in terms of population, land mass and diversity makes it difficult to make the changes. 3. There are political reasons as the CPI will lead to increase in the shown Inflation rate. This will in turn lead to loss of goodwill for the ruling party. 4. There is no single formula for calculating CPI in terms of India. Currently the CPI which are being calculated are being done by four different methodologies. 5. CPI figures are available on monthly basis while WPI is calculated on a weekly basis this gives little ground for Indian government to adopt CPI in calculating inflation. 6. The lag time of WPI is lesser than that of the CPI. 12 | P a g e

7. The source of WPI is more trustable. CPI in India is calculated by a few organizations the validity of their data is a serious question which has so far not been answered.

Why are other countries following CPI?
As stated earlier CPI is followed my most countries around the globe. It is interesting to know that India is one of the few countries which don’t follow the CPI. The Consumer Price Index was initially used by America during the First World War when rapid increases in prices, mainly in shipbuilding centers, made it necessary to develop an index to calculate cost-of-living. Later on it was adopted by the government in its calculations because people's buying habits had changed substantially. During the Second World War when most commodities became scarce and goods had to be rationed, the index weights had to be adjusted temporarily to show these shortages. In 1951, the BLS again made interim adjustments, based on surveys of consumer expenditures in seven cities between 1947 and 1949, to reflect the most important effects of immediate postwar changes in buying patterns. The index was again revised in 1953 and 1964. After that there was no end to CPI’s fame. It gave a better understanding of the standard of living, and was slowly adopted by more nations. The major favouring factors to CPI were: 1. The changing consumption habits of the consumers. 2. The spread of consumerism and the popularization of service industry like restaurants, etc led to a need for a new index. 3. The world war led to a change of responsibility for the female who were until then bound in the house in the western nation. This in turn changed the demand supply scenario. A new class was born. A new index was required to measure their needs. 4. As European countries started adopting it most other nations started adopting it. 5. The CPI was created to offer people, businesses, and government knowledge of the costs of inflation. 6. It covers food, beverages and other things which are not covered under other similar indexes.

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Why India is not following consumer price index?
At present, the wholesale price index is the most widely watched inflation gauge in Asia's thirdlargest economy as the government reports producer price data more comprehensively than consumer prices. The CPI is widely used as a cost of living index, but technically it is not. The CPI measures the average change over time in the prices paid by urban consumers for a relatively fixed market basket of goods and services. A cost of living index would measure changes over time in the amount that consumers need to spend to reach a certain utility level or "standard of living." The CPI completely ignores important changes in taxes, health care, water and air quality, crime levels, consumer safety, and educational quality. Furthermore, the experience of any individual may vary dramatically from what the CPI indicates, because an individual's purchasing patterns may differ considerably from the standard market basket. Families with children have considerably different buying patterns than elderly households, for example. The CPI does not even attempt to represent the experience of people living in rural areas. Inflation based on the wholesale price index accelerated at 9.36% in october, well beyond the central bank's comfort zone, bolstering chances of continued monetary tightening on top of the rate hikes that have already been done this year. Economists widely expected the policy rates to go up 0.50-1 percentage point in 2011 as authorities grapple with high inflation. The divergences in alternative inflation measures complicate the conduct of monetary policy in India, RBI governor D. Subbarao said in August 2009. “The Reserve Bank looks at all the measures of inflation, both overall and disaggregated components, in conjunction with other economic and financial indicators, to assess the underlying inflationary pressures.” Finance Ministry counters it saying that in India there are 4 CPI indices (CPI Industrial Workers, CPI Urban Non-manual Employees, CPI Agricultural Labourers and CPI Rural Labour) in existence which makes switching over to CPI riskier and complex and also CPI has too much lag time in reporting.

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Major hurdles in adopting Consumer Price Index1. A major problem area with standard CPI methodology is related to the first problem area and that is the treatment of seasonal commodities. The use of an annual basket or the use of annual expenditure shares is justified to a certain extent if one is interested in the longer run trend of inflation but if the focus is on short term month to month inflation (as is the focus of central banks), then it is obvious that the use of annual weights can lead to misleading signals from a short run perspective, since monthly price changes for commodities that are out of season (i.e., the seasonal weights for the commodity class are small for the two months being considered) can be greatly magnified by the use of annual weights. The problem of seasonal weights is a big one: in Canada, approximately 7% of the basket is not available at all at certain months of the year. Moreover, at least a third of the major commodity classes are subject to large seasonal fluctuations in weights. There are solutions to these seasonality problems but the solutions do not appeal to traditional CPI statisticians since they involve the construction of two indexes: one for the short term measurement of inflation and another(more accurate) longer term index that is seasonally adjusted.

2. Another problem with standard CPI methodology is that the problems of measuring complex services are generally neglected. In fact, a typical CPI will collect many more goods prices than services prices and will have many more commodity classes for goods rather than services. In a way, this just reflects the historical origins of existing CPI theory. As mentioned above, CPI theory has essentially remained unchanged for 80 years but 80 years ago, goods were much more significant than services, and hence, there was not much focus on the problems involved in measuring services. It is only over the last 30 or 40 years that the shift to services has caused service expenditures to exceed those on goods in many countries. However, if one looks at published CPI categories, there will generally be many more goods categories than services categories.

3. “Given the economic and demographic diversity that exists in India, a combination of different measures of inflation gives useful information on diverse aspects that is found to 15 | P a g e

be meaningful in formulating an appropriate policy,” it said. “Relying on a single index might result in loss of information on some crucial sectors and might be less useful in tackling the diversity of issues.” 4. Sampling errors The CPI measures the prices of only a sample of items from a sample of outlets in a sample of cities. The items are chosen by the use of the Consumer Expenditure Survey (CES). The interview portion of the survey, conducted quarterly from 5000 households, collects data on expenditures, assets, liabilities, incomes, large item purchases and household expenses. The diary portion of the CES (also administered to 5000 households) asks each sample household to make a complete record of all expenses for a two-week period. Another survey, the Point of Purchase Survey (POPS), is used to determine which outlets are used for prices. The Point of Purchase Survey is administered 16,800 individuals each year. It determines how much consumers spend for different classes of items and also how much they spend at each of the places from which the items were bought. Even after one has chosen a sample of items and a sample of outlets, one much choose which particular models or brands will be priced and on which day of the month prices will be sampled. An attempt is made to represent sale days and nonsale days in their proper proportions. The cities are sampled as well; the largest cities are always included and an attempt is made to choose samples from cities of intermediate and small sizes. This complex stratified sampling has errors simply because one cannot record the price of every item purchased by every household in every urban area.

5. Substitution bias The first problem with the CPI is the substitution bias. As the prices of goods and services change from one year to the next, they do not all change by the same amount. The number of specific items that consumers purchase changes depending upon the relative prices of items in the fixed basket. But since the basket is fixed, the CPI does not reflect consumer's preference for items that increase in price little from one year to the

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next. For example, if the price of backrubs in Country B jumped to $20 in time period 4 while the cost of bananas remained fixed at $3, consumer would likely purchase more bananas and fewer backrubs. This intuitive phenomenon of consumers substituting purchase of low priced items for higher priced items is not accounted for by the CPI. 6. Formula Bias Formula bias refers to a subtle problem relating to the fact that the initial quantities for items in the market basket were determined by dividing the current expenditure by the current average price. If the item happened to be on sale as of the point in time when they were first priced, that item would be systematically overweighted in the market basket and would bias the CPI upward because the prices of sale items tend to rise in subsequent months. The Bureau of Labor Statistics has developed a method called "seasoning" to adjust for this bias. 7. New Outlet Bias The opening of a new discount outlet may give consumers the opportunity to purchase the same goods at a lower price. The current CPI ignores these price changes. To take the price changes totally into account would bias the CPI downward, since purchasing at discount stores tends to be accompanied with lower levels of service; discount stores tend to have less knowledgeable sales staff, less variety, less convenient store hours, less liberal return policies. However, some economists believe that ignoring outlet switching effects altogether biases the CPI upward because price differentials are not totally offset by differences in service quality, especially as discount stores have taken advantage of more efficient technologies of distribution. For example, Wal-Mart, a discount chain., has the most sophisticated distribution system of any retailer. That Wal-Mart has become the largest retailer in the US suggests that consumers do not consider the Wal-Mart's lower prices to be offset by inferior service.

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8. Time of Month Bias The Bureau of Labor Statistics does not collect prices on weekends and holidays when certain items are disproportionately put on sale in certain outlets. There is some evidence that the fraction of purchases made on weekends and holidays has increased as well. This effect would make the CPI less representative of the average consumer and bias it upward. 9. Introduction of New Product The second problem with the CPI is the introduction of new items. As time goes on, new items enter into the basket of goods and services purchased by the typical consumer. For example, if in time period 4 consumers in Country B began to purchase books, this would need to be included in an accurate estimate of the cost of living. But since the CPI uses only a fixed basket of goods, the introduction of a new product cannot be reflected. Instead, the new items, books, are left out of the calculation in order to keep time period 4 comparable with the earlier time periods.

Why India should go for Consumer Price Index?
India is one of the few countries where the WPI is considered as the headline inflation measure by the central bank. This preference over the CPI is often explained in terms of three criteria – national coverage, timeliness of release (now only limited to food products) and its availability in a disaggregate format (Mohanty 2010). Of these criteria, only the last one is uncontroversial.

The concept of a wholesale price adopted in practice represents the quoted price of bulk transaction generally at primary stage. The price pertaining to bulk transaction of agricultural commodities may be farm harvest prices, or prices at the village mandi/market of the Agricultural Marketing Produce Committee/procurement prices, support prices. For

manufactured goods the wholesale prices are administered prices, ex-factory gate/ex-mill, exmine level. Ex-factory prices exclude rebate if any, other taxes and levies are excluded though excise duty is currently included. The difficulty this creates is clear in the case of agricultural commodities, where the WPI reflects not only market prices recorded in the mandis, but also 18 | P a g e

administered prices. For example, the WPI for wheat is a mixture of the mandi price and the government procurement price or the minimum support price (MSP) – (in the old WPI it used to be the public distribution system price) – thereby significantly attenuating the actual price fluctuations. This complicates not only the reading and analysis of the inflation rate recorded by the WPI, but also the communication to the public of the rate of inflation which is being used as a headline indicator.

Though there are some problems with consumer price index also, they can be improved or eliminated the central statistical organisation has given a report on it.

Report by CSOThe CSO released the new CPI with base year 2010 (Jan-Dec=100) on 18 February this year. Some features of the new CPI series are the following:

(1) The new CPI is disaggregated at the rural and urban level. The all India CPI is a weighted average of the two. This is in contrast with the earlier CPIs that represented specific classes of population (industrial workers, agricultural labourers, rural labourers, etc).

(2) The new series has a better geographical as well as commodity coverage than the earlier series.

(3) The weights have been derived from the 61st round of the NSS consumer expenditure survey (2004-05).

(4) Data for the urban CPI numbers will be collected from 310 towns (compared to 78 in the current CPI-IW, for all India) whereas for rural CPI numbers, 1,181 villages have been selected broadly on patterns of population distribution. Field officers of the NSSO and officials from the Department of Posts will be the price collection agents for urban and 19 | P a g e

rural centres respectively. The basket of consumer goods in the new CPI has also risen from 25 to 250.

(5) Since the two series are not comparable, inflation numbers based on the new CPI will be available only from February 2012. The share of food in the new CPI has seen a small dip in comparison to the CPI-IW while the share of services has risen. The share of housing has also seen a sharp rise. The new CPI will cover the entire population and not a specific group like industrial workers. In addition, the weights in the new CPI are taken from a recent consumer survey. The CSO has indicated that the weights shall be revised with next round of NSSO consumption expenditure survey in 2011-12.

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CHAPTER IV RECOMMENDATIONS AND CONCLUSION

The economic world today demands for a more dynamic index actions. Inflation today is already touching two digit figures. At this point it is important to know the actual inflation percentage so that corrective actions can be taken on time. The traditional ways of doing things need to be relooked into and new methods need to be adopted to ensure continuous growth. India is at that threshold where it needs to take such a decision and change its practices. WPI system of indexing is old and outdated. It needs to be upgraded or replaced by better systems. The process will not be a simple one but, one which needs to be taken at the earliest.

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Bibliography:
1. http://ecocraze.blogspot.com/2008/10/wpi-vs-cpi.html 2. http://www.thefinblog.com/2008_07_01_archive.html 3. http://dare.co.in/strategy/legal-policy/the-head-and-tail-of-wholesale-price-index-vsconsumer-price-index.htm 4. Gaping holes in measuring inflation, Economists V Shunmugam and D G Prasad, commodity online, 2006 5. Economic Section, 31 October 2007 India Economic: Paradox of Inflation 6. Developing trends, volume 1 issue 1, march 2011.