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A new base year for inflation, but is it old wine in a new bottle?
September 16, 2010

We look at the changes in the WPI index brought by the change in base year as well as its effects going forward

Author : Manjunath Gaddi

Untitled Document

Key Points:

  •  A revised WPI index has been released with the new base year of 2004-05
  •  The revised WPI index has expanded the list of commodities as well as the number of price quotations to be considered
  •  The weightage of primary articles sub index has been reduced by almost 2%, while the other two sub-indices, Fuel and Power, and Manufactured Products have seen increase in their weightage
  •  The revised WPI Inflation is 8.5% for August and is well above the RBI’s target level of Inflation
  •  With 13.8% growth in industrial production and robust GDP growth, the RBI may hike Repo and Reverse Repo rates in the monetary policy review tomorrow

The Wholesale Price Index (WPI) released by the government had 1993-94 as the base year or reference point for calculating inflation but on 14 September 2010, the government released the WPI Index for the month of August with the new base year of 2004-05. The year-on-year (Y-o-Y) inflation with the new base year (2004-05) stood at 8.5%, while the Y-o-Y inflation with the old base year (1993-94) stood at 9.5%.  The 1% drop in inflation cheered by the markets was essentially due to the change in base year.

Basically, the WPI Index measures the changes through time in the price of the goods commonly used as inputs in industry or sold at wholesale level. This is the index that the policy makers and the markets generally refer before taking actions. It helps us compare the rise in prices of various commodities with respect to that year. The index value of the base year is always pegged at 100, so that it’s easier to measure the changes in inflation. 

Why a New Base Year for Inflation?

The old WPI index with the base year 1993-94 was adopted in the 1990s however, our economy has grown by leaps and bounds i.e., more than 400% since 1994-95. Many new products have been introduced which were not available in 1993-94 and also many products were not included in the old inflation index. All of this necessitated the creation of a revised WPI index with a new base year and composition to give our policy makers and markets a clearer picture of inflation.

So, a working group under the chairmanship of Prof. Abhijit Sen was constituted by the government to bring about the changes in the index which would reflect the current structure of the economy. The same group suggested 2004-05 as the base year as there wasn’t any abnormal price movement of major commodities in the index during the particular year.

Old Wine Vs the New wine

In the revised WPI index, the government has expanded the list of commodities as well as the number of price quotations taken. Table 1 highlights the structural changes in the index. The revised WPI index might not give the exact ground-level picture of prices but gives a clearer indication of inflation than the older WPI Index.

Table 1: Comparative Statement of Commodities and price quotations

No of Commodities No of Price Quotations
1993-94 2004-05 1993-94 2004-05
All Commodities 435 674 1918 5482
    Primary Articles 98 102 455 579
    Fuel and Power 19 19 72 72
    Manufactured  Products 318 555 1391 4831

 The revised WPI index has retained all the three major sub-indices found in the older WPI Index which are Primary Articles, Fuel and Power, and Manufactured Products. The Primary Articles sub-index covers food articles, non-food articles and minerals. The Fuel and Power sub index covers mainly the petroleum products while the manufactured products sub-index, which makes up the bulk of the WPI, covers many industries with a huge list of 555 items.

Not only has the number of commodities in the index changed but also the weight-ages of the sub- indices have changed. Table 2 shows the changes in the weights of the sub indices.

Table 2: Weightage of the Sub Indices

1993-94 2004-05
All Commodities 100% 100%
   Primary Articles 22.025% 20.118%
   Fuel and Power 14.226% 14.910%
   Manufactured Products 63.749% 64.972%

 Highlighted are the major changes in the index:

  • The primary articles sub-index has seen a drop of almost 2% in its weightage, while the other two sub-indices have seen an increase in their weightage.
  • The food articles, a component of the primary articles sub-index, has been in the news due to high levels of food inflation and is the primary reason for high WPI inflation. One important change in the measurement of the food inflation has been in prices of Rice and Wheat. In the old index, the Public Distribution System (PDS) prices of Rice and Wheat were used but in the revised index, the procurement prices of paddy and wheat would be used.  Since the PDS price is much lower than the procurement price, we could see minor hikes in inflation whenever the government announces procurement prices of these commodities
  • Fuel Price changes has both, a direct and indirect impact on the WPI Index. The direct effect is seen in the change in the Fuel and Power sub-index. The indirect impact is seen in all the other commodities as the prices of other commodities tend to rise and fall with the rise and fall of fuel prices. With the new weightage, the index has become more sensitive to changes in fuel prices in comparison to the old index. With the new deregulated fuel price regime and the new weightage, the WPI index will rise and fall faster than the older index thereby reflecting a clearer ground-level picture; this factor coupled with the global crude prices will also make the index more volatile

However, in comparison to the older Wholesale Price Index, the new WPI  tends to give lower inflation values. This can be seen in Chart 1 below, which shows the Y-o-Y inflation according to both the old and new WPI indices. The lower values of the revised WPI index can be attributed to a drop in the weightage of the Primary articles sub-index, enhanced list of commodities and huge increase in the number of price quotations.

Our View on the Revised Index

The revised inflation index prepared by the government is in the right direction as it has made changes in the weights assigned to the different sub-indices and has also included more items making it a much broader representation of the structure of the economy.

Even though the WPI Inflation is 8.5% for August, it is well above the RBI’s target level of Inflation.  This along with the 13.8% growth in the industrial production for July and strong Q1 FY 2010-11 GDP, will give the Reserve Bank of India the necessary leeway to hike the Repo and Reverse Repo rates by 15 to 25 basis points in the Monetary Policy Review which will take place on 16 September 2010.

In the medium term, we expect inflation to moderate on the back of lower food prices due to good monsoons coupled with the fact that the crude prices are not expected to rally until the developed economies show definite signs of revival.
Chart 1: Comparision of the old and new wpi indices

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