[Economy] Index Theory: WPI, CPI, IIP, Components, Baseyear; Core vs Headline inflation, Laspeyre’s formula explained

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Majid Hussain
  1. Prologue
  2. [Act 1] WHO calculates WPI, CPI, IIP?
  3. [Act 2] WHEN they publish WPI, CPI, IIP?
  4. [Act 3] WHERE do they get data for WPI, CPI, IIP?
    1. WPI Data Collection
    2. CPI Data collection
    3. IIP Data Collection
  5. [Act 4] WHAT are the components of WPI, CPI, IIP?
    1. #1: WPI components of Wholesale price index
      1. What is Headline inflation WPI?
      2. What is Core inflation WPI?
    2. #2: CPI components of Consumer Price Index
      1. What is Headline CPI inflation?
      2. What is Core CPI inflation?
      3. Consumer Food Price Index (CFPI)
    3. #3: IIP: Sectorwise Components?
      1. IIP : Goods-wise Components?
  6. [Act 4] WHY REVISE WPI, CPI, IIP series?
    1. Revision of Wholesale Price Index (WPI)
    2. WPI: New items added:
    3. Saumitra Chaudhuri Committee on WPI
    4. Revision of Consumer price index series (IIP)
    5. Revision of Industrial Index production (IIP)
    6. Comparison: WPI, CPI, IIP
  7. [Act 5] WHY WPI, CPI, IIP important?
  8. [Act 6] Other indexes
    1. Service performance indices (SPI)
    2. Baltic Dry index
    3. Producer Price Index (PPI)
    4. Some more indexes
  9. [Act 7] Laspeyre’s formula

Prologue

Chapter 4: Prices and Monetary Management. Three subparts

  • Monetary management, measures of money supply, Urjit Patel
  • Indexes’ Theory: WPI, CPI, IIP, Services index and others
  • Indexes’ Current: Survey observations on WPI, CPI & IIP, How to combat inflation.

Wait…what happened to remaining chapters?

  • Ch. 8 to 13 published as articles.
  • Chapter 1 to 3; 5 to 7 available as powerpoint and videos. (Will release them as articles after prelims and its “unofficial” answerkey.)

[Act 1] WHO calculates WPI, CPI, IIP?

Compare-WPI CPI IIP

WPI
  • Office of the Economic Adviser
  • In DIPP Department of Industrial Policy and Promotion
  • In Ministry of Commerce & Industry.
CPI
  • Central Statistics Office (CSO)
  • Ministry of Statistics and Programme Implementation (MOSPI)
IIP Same as CPI

[Act 2] WHEN they publish WPI, CPI, IIP?

WPI data publication

Weekly
  • Every Thursday: Primary Articles and Fuel Group
  • If Thursday is holiday then next working day
Monthly
  • 14th of Every month: all commodities
Final
  • Above two are “provisional” because some prices are not available.
  • Final list released two months (~EIGHT weeks). When they get authentic price data for all commodities.

If holiday, then WPI data released next working day.

CPI and IIP: When published?
CPI
  • Monthly basis: for urban, rural, all India.
  • Annual: with lag of one month.
  • State/UT’s separate CPIs released only if they provide 80% of the necessary data.
IIP
  • monthly basis with the time lag of six weeks from the reference month.
  • Although IIP just a short term indicator. The actual result come along with Annual Survey of Industries (ASI).

[Act 3] WHERE do they get data for WPI, CPI, IIP?

So far we know, who makes the index, and when they release it. But WHERE do they get the statistical inputs?

WPI Data Collection

Primary articles Respective ministries, dept, PSU, State Governments
Fuel and power Same as above
Manufactured products Leading manufacturing units
total 676 items

Problems in Data collection

  1. Since the collection of prices is on voluntary basis, the flow of price data, especially from manufacturing units, becomes irregular leading to problems in compilation of Wholesale price index.
  2. Economic Adviser has created a webportal, so factory owners can directly supply data. But momentum not picked up yet. Seems they’re too busy changing profile pics on facebook.
  3. Therefore, Economic Advisors has made arrangement with NSSO to collect price data from the manufacturing units, until webportal becomes popular.

CPI Data collection

Who gives data for Consumer price index (CPI)?
Urban areas NSSO officials survey. Data entered into NIC web portal.
Rural areas NSSO officials + Postal Officials (if NSSO can’t reach). Not all villages surveyed, only ~1200 villages.

IIP Data Collection

Who gives data for Index of Industrial production (IIP)?
IIP information Supplier  Items
DIPP: Dept of Industrial Policy & Promotion 430
Indian Bureau of Mines 61
Iron & Steel Joint Committee 47
Chem. & Petrochemicals Dept. 47
Textile Commissioner 44
Vanaspati Directorate 11
Jute Commissioner 11
Petroleum ministry 11
Railway Board 6
Fertilizer Department 6
Coal Controller 3
Directorate of Sugar 1
Salt Commissioner 1
Tea Board 1
Coffee Board 1
Central Electricity Authority (power Min.) 1
Total items 682

[Act 4] WHAT are the components of WPI, CPI, IIP?

#1: WPI components of Wholesale price index

Components WPI

  • Economic Advisor, Lespeyer’s formula, Base year 2004.
Three categories, in descending order of Weight
WPI components weight
Manufactured ProductsInternal weight: Chemical >metal > food 64.97
Primary Articlesinternal weight:Food > Nonfood > Mineral 20.12
Fuel & Powerinternal weight: Mineral oil > Electricity >Coal 14.91
total weight 100

These three categories are further subdivided into picture worth 1000 words.

Mindmap Wholesale price index

What is Headline inflation WPI?

  • Number we get from all components viz. primary, fuel and mfg.

What is Core inflation WPI?

  • core means, we should ignore food and fuel part.
  • So, core inflation = Only WPI of Non-food manufacturing industries.
  • Headline WPI – (primary + fuel + food mfg. industries)

#2: CPI components of Consumer Price Index

Components CPI

  • CSO calculates using Lespeyer’s formula, Base year 2010
  • Five category of items. I’ve arranged them in descending order of WEIGHT (Combined All India)
CPI components Rural Urban Combined
Food, beverages, tobacco 59.31 37.15 49.71
Misc.Health edu etc. 24.91 28 26.31
Housing NA 22.53 9.77
Fuel, light 10.42 8.4 9.49
Clothing,bedding,footwear 5.36 3.91 4.73
Total 100 100 100

Mind it: Rural CPI doesn’t consider Housing inflation.

Mindmap CPI combined

Subcategories Ranking: CPI (Combined)
Ranking within that highest weightage given to
food, bev., tobacco Cereal > Milk >Veggies > …..Sugar (lowest)
Fuel and light no subgroup
clothing, bedding, footware (Clothing-bedding) > Footware
Housing No subgroup.
Misc. Transport > Medcare > Household requisites>…>Recreation (lowest)

What is Headline CPI inflation?

The number you get from combined data of above categories.

What is Core CPI inflation?

Core CPI =Headline CPI MINUS (food and fuel components.)

Consumer Food Price Index (CFPI)

  • By the same good folks who calculate CPI (=CSO-walla)
  • Using same Laspeyre formula
  • Using same base year: 2010
  • If total weight of CPI = 100, then Food price index = ~52% of its weight

 

Components in descending order
Components Rural Urban Combined
Cereals and products 36.71 28.51 34.16
Milk and products 16.53 21.59 18.1
Vegetables 12.64 12.93 12.74
Oils and fats 8.98 9.44 9.13
Egg, fish and meat 6.5 7.38 6.77
Pulses and products 6.25 6.11 6.2
Sugar etc. 4.64 4.11 4.47
Fruits 3.65 6.14 4.43
Condiments and spices 4.1 3.79 4
Total 100 100 100

So far we are done with components of WPI, CPI and food inflation. Moving on

#3: IIP: Sectorwise Components?

Components IIP index

Weight: Mfg >> Mining >> Electricity
sector weight items itemgroups
Manufacturing 755.27 620 397
Mining 141.57 61 1
Electricity 103.16 1 1
total 1000 682 399
  • Mind it: Total weight is 1000. So, if you want percentage weight, then shift decimal one point to left.
  • For example: manufacturing weight = 75.5%

IIP : Goods-wise Components?

IIP data released in two formats

  1. Sector wise: Mining, mfg, electricity (that we just saw above.)
  2. Goods category wise using the same components as above, but data presented for goods category wise….as shown below.
Basic Goods Any bulk raw material/product used in manufacture. High Speed Diesel, Aviation Fuel, Kerosene, Urea, Cement all kinds, Granites, iron, copper and Electricity
Capital Goods Plants, machinery and goods used for further investments. Boilers, compressors, engines, Transformers, Commercial Vehicles and all machineries like Textile Machinery, Printing Machinery etc.
Intermediate Goods used for manufacturing of another product. Cotton yarn, Plywood, Adhesives, Aluminum and steel pipes etc.
Consumer durable can be used for more than 2/3 years). Pressure Cooker, AC, tyre, Tv, mobile, automobile, Gems and Jewelry etc.
Consumer non-durable can’t be used for long periods. Fruit Pulp, edible oil, milk powder,  tea, Cigarettes, Apparels, Newspapers, Antibiotics etc.

 

Goodswise weight, In decreasing order:
IIP Weight
Basic Goods 456.82
Consumer non-durable 213.47
Intermediate Goods 156.86
Capital Goods 88.25
Consumer durable 84.6
total weight 1000

IIP-8 core industries

  1. Within IIP, following 8 are core industries because they’ve impact on almost all other economic activities:
  2. Coal, fertilizer, electricity, crude oil, natural gas, refinery products, steel, and cement.

IIP- Deflation

  • IIP is a quantitative index, the productions of items are being expressed in physical terms.
  • But for some items, the information is received in “Value” term rather than quantity or volume.
  • So, CSO uses WPI as a deflator to convert that “price” into “volume”.

[Act 4] WHY REVISE WPI, CPI, IIP series?

Now time for a “FLASHBACK” in this movie

index new series effective from
CPI 2011, January
WPI 2010, September
IIP 2011, June

So if these are the new series we talked about then what was the system before that?

Revision of Wholesale Price Index (WPI)

The WPI series has to be revised often, because of two reasons:

#1: base year

  • Inflation is a “relative” concept. When we say there is inflation – it means things used to be cheaper at some previous year.
  • So, to calculate WPI, we need a base year. Base year should be revised once in a while.

#2: product mix

  • WPI calculates inflation using Laspeyres formula for weighted arithmetic mean.
  • But this formula fails to capture the dynamic changes in product mix and structure of the economy over time.
  • For example, 15 years ago, price of VCR and magnetic tape cassettes would have mattered. But no one uses them anymore.
  • Same way, 15 years ago, people did not buy that much moisturizer creams and perfumes.
  • Hence we’ve to keep changing the components.
Based Abhijit Sen Committee
BEFORE AFTER Sen Committee, WPI reform
New system Started from 2010, Sep
Base year 1993 2004
435 items 676
Increased no. of price quotations
  1. If factory directly exports, then don’t count that value in WPI
  2. If factory directly imports an item, don’t count it in WPI.
Added new items.

WPI: New items added:

List not exhaustive

Primary articles

  • Lemon, Gaur Seed, Rose, Jasmine, Marigold
  • Crude petroleum, Copper Ore, Zinc Concentrate

Manufactured items

  • Computer Stationery, UPS, SMPS, VCD player
  • Dish Antenna, Fibre Optic Cable
  • Perfume, Scent Cream, Moisturizer, Body Powder
  • Leather Gloves, jackets, garments, bags
  • Football, Toothbrush

Saumitra Chaudhuri Committee on WPI

Current WPI Saumitra recommends
676 items ~1200 items.
11 vegetables 17
Expected to be operational from next year
Collect prices from more centres, to get better estimate.
Reduce weight of primary food items. Increase weight of mfg. items
Base year 2004 2009, And then to 2011

Enough of WPI, moving on

Revision of Consumer price index series (CPI)

PROLEM Before SOLUTION After
Started from 2011, January
base year 2010
Specific groups only.(Baseyear in bracket)

  • Industrial workers (2001)
  • agricultural laborers (1986)
  • rural laborers (1986)

Problem= doesn’t give “whole” picture

  1. Rural
  2. Urban
  3. combined (+ state/UT wise separately released)
  4. Consumer Food Price Indices (CFPI).
Item list designed based on NSSO’s 2004 survey. In future, CPI will be revised using NSSO’s 2011 survey.

Mind it: this doesn’t mean they no longer calculate CPI for industrial workers; Agro & rural laborers. They still do it.

Revision of Industrial Index production (IIP)

  • Each IIP item should have certain minimum contribution to national production.
  • For example VCR industry’s contribution in Today’s economy = 0%
  • Therefore, need to update list with based on technological changes, economic reforms and consumption patterns of the people.
IIP Before IIP After
C.P. Chandrasekhar Committee
Base year: 1993 2004
Added new items: Apparels, Gems and Jewellery, Newspapers,  pasteurised Milk, Writing & Printing Paper, Ayurvedic Medicaments, Woollen Carpets, Wood Furniture, Terry Towel, Coir Mats & Mattings, Polythene Bags, Instant Food Mixes, Fruit Pulp etc.
Information source agencies: 15 16.

  • MSME dropped as a source agency.
  • Chemical and Fertilizer Department  added
  • So +2 minus 1 = 1 increase
NIC-1987 Items used from National Industrial Classification (NIC)-2004
  • Increased weight given to mining and electricity
  • Decreased the weight given to manufacturing
  • Asked MSME ministry to develop a separate index for MSME sector

Comparison: WPI, CPI, IIP

What did we learn so far?
QUESTION WPI CPI IIP
HOW? Lespeyre’s formula same same
WHO? Economic advisor CSO CSO
WHEN? weekly & monthly monthly monthly
WHERE they get data? ministries, dept., industries NSSO and Postal workers ministries, dept, bodies
Components 3: MFG > Primary > Fuel 5 categories 3: MFG > Mining >electricity
types only one WPI Rural, urban, combined Sector wise and goods Usage wise.
items 676 682
base year 2004 2010 2004
CORE non-food manufacturing headline – (food+fuel) 8 industries

[Act 5] WHY WPI, CPI, IIP important?

Yes, why bother calculating WPI, CPI and IIP in the first place!?

Why is WPI important?

Monitors the dynamic movement of prices.

Who Why they use WPI?
Government To design  trade, fiscal and other economic policies
RBI To design monetary policy, under Multiple indicator method: RBI used WPI. (But Rajan started using CPI for this purpose, since April 2014, on Urjit patel recommendation.
Businessmen In the business contract- to calculate price escalation clauses in the supply of raw materials, machinery and construction work.

Why CPI important?

Measures the price of goods that households consume.

Government
  • Monitoring price stability.
  • Calculating Dearness Allowance
  • Using as “DEFLATOR” in national accounting
RBI
  • To design monetary policy from April 2014 onwards, based on Urjit Patel recommendation.
Businessmen Calculating Dearness Allowance

Why IIP important?

  1. The IIP measures volume changes in the production of an economy
  2. Provides a measurement that is free of influences of price changes
  3. Data used in Government policy planning purposes, Industrial Associations, Research Institutes and Academicians.

[Act 6] Other indexes

Service performance indices (SPI)

Index Does it cover service sector inflation?
WPI Nope
CPI Partially e.g. education, healthcare
IIP
  • It doesn’t capture “inflation”. It captures increase / decrease in “production”.
  • But here too, Service sector production not counted.
  • Anyways, Economic Advisor started services price indices (SPI). (recall he also does the WPI).
  • On experimental basis.
  • To capture inflation in following service sectors:
Railways SPIs freight and passenger services
Banking SPIs
  • services for which banks charge fees, commissions, brokerage, etc.
  • RBI gets them data from 21 banks (13 sarkaari, 4 private, 2 foreign, 1 cooperative and 1 RRB).
Postal SPIs
  • only Department of Posts.
  • Hardly tells anything, because it IGNORES following:
  • Private courier companies
  • postal service to armed forces (for national security issue)
  •  money transfer via Western union, IPO, money order; revenue stamps.
Telecom SPIs only for cellular services on the basis TRAI report. Quarterly basis.

All of them use same Laspeyre’s formula.

Baltic Dry index

  • London based Baltic Exchange, releases this index number on daily basis.
  • Measures cost to transport raw materials by sea.
If Baltic number meaning
Increases
  • More raw material shipped. World economy growing
  • Was highest in May 2008 (~11,800).
Decreases
  • Reverse impact on economy.
  • After 2008, After that continuous decline due to subprime, and eurozone crisis.
  • Lowest May 2014 (982)

Producer Price Index (PPI)

  • measures price change from the perspective of the seller.
  • i.e.  average change in selling prices received by domestic producers for their output.
  • Covers both goods + services. (WPI only covers goods)
  • Sellers’ and purchasers’ prices differ due to government subsidies, taxes and distribution costs. Therefore, better to use PPI. Bcoz CPI doesn’t cover this.
  • Majority of the OECD countries measure inflation based on Producer Price Index (PPI)
  • WPI has been replaced in most countries by Producer Price Index (PPI) due to the broader coverage provided by the PPI in terms of products and industries
  • PPI has more concordance with system the national account. (compared to WPI)
  • Therefore, Office of the Economic Adviser (OEA) has taken up the initiative for constructing a Producer Price Index (PPI) for India.

Some notable countries

  • Ireland uses BOTH WPI and PPI
Only WPI Only PPI
Japan, Australia, Greece, Norway and Turkey Canada, USA , Aussies, S.Korea, UK, Spain, Italy

Some more indexes

RBI
  • Inflation expectation survey of households.
  • For three months and 1 year ahead periods.
OBICUS
  • Order Books, Inventories and Capacity Utilization Survey (OBICUS)
  • By Reserve Bank of India (RBI)
  • To assess consumption and investment demand
  • Surveying ~2500 companies in manufacturing sector
  • Timeframe: quarterly
ASI
  • Annual survey of Industries
  • By NSSO under Statistical ministry
  • To survey manufacturing sector’s growth and structure
  • Surveying every mfg. unit employing 10 workers or more.
  • Annually
HSBC
  • India Manufacturing Purchase Managers’ Indices (PMI).
  • Monthly basis
NEER|REER
  • will see them when I publish articles for ch6 and 8….in the meantime you may refer to the powerpoint or lecture videos..

[Act 7] Laspeyre’s formula

Not for prelims. But when they want to begin “STRESS” interview particularly during bank/MBA.

  • Laspeyre was a German economist .
  • His formula used in calculation of WPI, CPI, IIP, service price indices.
  • It is a Weighted arithmetic mean.

Let’s understand with a crude example.

  • Suppose a local thug’s “INFLATION” index uses following format, with 2004 as base year.
  • He can only decide the base year and weights assigned to each components on his own. Condition: he should distribute the weight in such manner that total weight is 10, 100, 1000- that way % calculation is easier.
  • After that, monetary policies, fiscal policies and market forces will determine the prices in base year and current year. He just has to apply formula.

So, excel data looks like this:

Components weight 2004 prices 2014 prices
Desi liquor 10 Rs. 10 Rs. 15
Gutkha 20 Rs. 2 Rs. 5
Cinema 70 Rs. 50 Rs. 75
Weight 100

First, I’ll find relative price (Current prices divided by BASE year’s prices)

Components weight 2004 prices 2014 prices R
Desi liquor 10 Rs. 10 Rs. 15 1.5
Gutkha 20 Rs. 2 Rs. 5 2.5
Cinema 70 Rs. 50 Rs. 75 1.5

Now I’ll multiply Relative price with weight assigned to each components

Components weight 2004 prices 2014 prices R RxW
Desi liquor 10 Rs. 10 Rs. 15 1.5 15
Gutkha 20 Rs. 2 Rs. 5 2.5 50
Cinema 70 Rs. 50 Rs. 75 1.5 105
Total 100 170
  • Finally, the addition of RXW will me index number for current year. 15+50+105=170.
  • That means Current inflation in 2014, is 70%, compared to the prices in base year 2004.
  • In 2015, If I get the number 180=80% inflation than base year (2004)
  • But compared to 2014, the 2015’s year on inflation would be (180-170)/170=~6%.

Statistically we can express with this formula:

Lespeyers formula inflation index

Note: some books use P0/Q0, it’s basically the same. Because they take “weight” as = (p x q).

Some other indexes (only GIST, not going in details)
Paasche index Tells us what today’s “Basket” of commodities, would have cost @yesterday’s price.
Fisher index Geometric mean of  (Laspeyrese and Passche). This solve the problem of “substitution bias” in consumer Expenditure.
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99 Comments on “[Economy] Index Theory: WPI, CPI, IIP, Components, Baseyear; Core vs Headline inflation, Laspeyre’s formula explained”

  1. Thank you very much Sir.. Your notes are “bull’s eye”..

  2. Thank u sir.

  3. sir, this article need some update due to some change by the ministry, e.g. base year of cpi is 2012 now.

    1. articles divided into how many category in wpi

  4. Cpi base year changed to 2012 , please update.

  5. Hello sir,
    Your way of teaching is very awesome. Though I hail from South India, I can understand your way of teaching in Hindi. Thank you very much for your excellent classes.

  6. Sir,
    ANNUAL SURVEY OF INDUSTRIES is conducted by CSO , right?

  7. Mrunal Sir, I have a question. What is the impact of inflation in Import and Export? Is there a direct answers to it? Several article say that it helps in boosting Export because the currency is weak when inflation in high. But some article say it will decrease Export because the domestic prices are higher and more profitable leading to less tendency to export.

    1. Acc. to what I have read, it decreases the export. Because if there is inflation, the cost of raw materials increases. The high price of raw materials increases the total price of the goods, hence the amount you had been earning by selling outside the country becomes less, so export becomes LESS viable.
      and due to the inc. in cost, it creates an opening in the domestic market for cheaper goods, which can be imported from outside.
      This results in an unfavorable Balance of Payment.

      if you need to tackle or control inflation.. you need to import goods at lower prices to satiate the needs of the people else they would be forced to buy domestic products at a higher price and this too is not favorable.
      Economics is tricky! You win some, you lose some.

      I hope I am right!! If you have found a better answer, please correct me!

    2. The impact of inflation on exports is not absolute. It may facilitate or impede growth and there’s no one way to see it.
      1. Exports decrease due to rise in input cost making the final product less attractive.
      2. To overcome the shortage of goods or inputs, the product is imported. Thus increasing the imports.
      3. Rise in imports (means rise in demand of foreign currency in the domestic market) is likely to depriciate the exchange rate.
      4. This depreciation gives the domestic currency a competitive edge making exports relatively cheaper and hence facilitating them.

      However this is a mere speculation since there’s little evidence of cause and effect. We can only correlate. And hence, what you’ve read is correct in both ways.

  8. how weights are assigned

    1. We assign weight to each commodity relative to its importance. More importance means more weight.

  9. Yes u r right mam

  10. Weights means Durable and Non-durable

  11. What a coverage!

  12. very useful information, compiled at one place, very nicely explained in simple language….thank this information is very useful for me

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