Inlation control is the buzz word everywhere. But in India the relevance of the term is still not fully understood.

The concept is still theoretical. A rise in inflation is assumed to mean that the common man will have to pay more in the market. But many a time, a rise in essentials does not show in the actual level of inflation that is presented to us.

Well statistics in India have never been accurate and do not reflect the reality of things.

India, although set to become an Asian tiger, still lacks professionalism as far as forecasts and techniques are concerned. We are still living in the dark ages where economy was closed and not much happened.

Similar is the case with inflation index calculations. We base our calculations on outdated indices. We do not even bother to make an attempt to make it more realistic. That is why the actual state of affairs is not reflected in the data that emerges.

Take the case of inflation. We still base our calculation on the 1981-82 base when India functioned in a close network and was not accessible to external influences. The government continues to weight items that today are not relevant in computing figures and making future projections. End result -- what comes out does not reflect the actual situation.

Several groups of commodities, which do not enter the consumption basket directly, are included in the index. Further there are several commodities, which the consumer spends on, that are not even mentioned in the index. This ambiguity needs to be dispensed with if India is to make any progress in achieving its forecasts .

World over, the Consumer Price Index (CPI) is used as an indicator of the price level in the economy. But in India it is the Wholesale Price Index (WPI) which is used. It is basically divided into three sections -- primary articles, manufacturing products, and fuels, lights and lubricants. This index covers prices all over the country and is thus a national index. As it deals with wholesale prices it does not include any services, when these are so relevant.

CPI is a more correct reflection of the price situation as it is calculated at the retail levels and covers all categories of industrial workers, agricultural labourers, and urban non manual workers. The consumption habits of these categories vary significantly between towns and cities.

But now that we have a revamped WPI with 1993-94 as the new base index, with change in the composition of commodities in the basket, it is likely that we will have a more realistic rate of inflation in the future.

Reflecting the higher stage of development in the Indian economy, the WPI will give greater weightage to manufactured products. This is also true for fuel and energy items the consumption of which increases as the economy grows.

In the old series, primary food articles had a high weightage. This will be steadily bought down. The implications are quite interesting. For one, global manufacturing prices will be reflected even more acutely in the inflation rate in India. It was because manufacturing prices were stagnant in 97-98 and 98-99 that the WPI growth was low. Again world over there was a recession and the fall in international commodity prices affected locally manufactured goods, particularly because imports tariffs in India had been coming down over the years.

Only recently have the international prices begun picking up and this should reflect in a higher rate of inflation in the coming months.

Most importantly the wild fluctuations in the food prices due to climatic conditions and regional shortages will show up less in the new WPI basket because the weightage of primary commodities is down by 11 percentage points.

And as India gears to a higher growth trajectory the consumption of fuel will increase in the economy and in future, fluctuations in international oil prices will have a greater impact on the WPI.

The Indian economy has matured considerably in the liberalised regime. But its importance has not been getting captured in the basket of manufacturing items shown in the WPI.

Most economic growth indicators are very closely related. Take the instance of GDP, rupee value, interest rates, import prices and above all government expenditure. If the government defaults on its set targets all these indicators can go haywire and bring about total fiscal chaos.

What India really needs to do at the moment is to try and bring about an index that is relevant to current happenings and reflects the changes that are taking place in the economy.

Internationally, the concept of WPI does not exist since there is no dichotomy between retail and wholesale prices. This is because the margins are very narrow as the markets have perfect integration. But India lacks basic transport infrastructure which makes movement of goods difficult across the country and invariably causes divergence in prices across the country. As transportation costs are very high it is but natural that the WPI and CPI will differ significantly.

As long as India does not make any attempt to improve its infrastructure, which will help reduce transport costs, there will always be a wide gap experienced between these two indices.

The WPI takes into account several items like metals, electronic goods, and capital goods which do not enter our consumption directly. Thus accountability becomes difficult. On the other hand CPI considers housing, transport, and food articles which are very relevant to the common man and enter consumption directly. In such a case how can we arrive at a common hypothesis for both indices?

The calculation of the index is also flawed. We have statistical data and monthly data which have several variations as inflation normally follows a seasonal pattern. Again depending on whether the base of comparison is high or low, we may emerge with completely different pictures. If the agricultural produce is good, inflation may reflect a higher peak as spending power is higher. Reverse is the case if the harvest fails.

Normally a common man use the point to point concept to judge inflation. But this is not a very correct index as it captures only the day to day happenings. Thus average inflation is a better index as it is calculated over a period of time taking into consideration the different situations that arise.

In India inflation is based mainly on the performance of the agricultural sector. Since agriculture is more dependent on natural forces, it causes great volatility in the inflation rate. In 1997 and 1998 there was a slump in agricultural production resulting in a spurt in food grain prices. But fortunately 1999 turned out to be a bumper harvest with reasonably good rainfall and buffer stock at 5 million tonnes. The result is that the overall rate of inflation has fallen to between 2 to 3 per cent.

It has been predicted that this year the monsoon may be below average and drought in several parts will once again see prices spiralling. With several parts of India in the midst of a severe water and food shortage the government is once again using its buffer stocks to provide for daily needs. Two million tonnes have already been sanctioned from the Prime Minister’s Relief Fund . This unexpected calamity coupled with fall in agricultural production next year and the government’s firm no to roll back in subsidies will see inflation peak to higher levels.

If you look at the inflation rates for the developed countries a very different picture emerges. Firstly the calculation is on a retail level with CPI as the main index. As the markets are more integrated there is less volatility in the inflation rate.

But this is not the case with India. In India inflation is measured on the national index which does not capture reality.

India opened up way back in the early 1990’s. As Mr PR Brahamananda, a leading economist, said, a steady low rate of inflation should be seen as no more than a predictable and desirable consequence of liberalisation. Increased competition is expected to keep prices down. Lower margins to industry will be offset by higher growth.

In this scenario of low margins and high growth, industry would only be able to afford a lower real rate of interest. This would put pressure on banks to reduce their lending rates which would be possible only if the cost of funds to banks is bought down. This would be possible because the higher growth rate would make additional savings available to the banks.

The lower rate of inflation would reduce the resistance of depositors to lower interest rates. This would result in both rate of inflation and interest rates settling down at lower levels.

With agriculture expected to perform below average this year and only the knowledge based industries contributing to growth, the common man is not optimistic about a lower rate of inflation.

Confidence building will be a difficult exercise. The government has been reassuring through its various policy documents that there is no cause to worry and that monetary aggregates are well within control.

But today the common man is not ignorant. He is well aware of what his purchasing power is. It is only when things go out of control that the government realises that it has waited for too long for things to settle down. It is then that drastic and harsh measures are taken. Then the difficulties that the common man would have to face, are not considered.

It is the poor and the fixed income groups that suffer the most because wages do not match up to the inflation rate. Normally in India it is noticed that wages rise much slower than prices.

The crux of the problem lies in the lack of infrastructure which distorts financial functioning. Today Indian financial markets are not integrated unlike internationally where shocks in one market are automatically reflected in other markets.

In India the money market, stock market and forex markets are still in a nascent stage and although a beginning has been made it will be a while till full integration is achieved.

The government has resorted to a tight monetary policy and slashed the interest rate by around 100 basis points on PPF and other savings. This will have dire consequences as it will reduce the common man’s urge to save. This would hurt demand and this is the last thing that industry wants at the moment as it is already operating with lower margins.

Looking at this year’s subsidy bill it is difficult to imagine where the government will source its funds from. This year’s subsidy according to the Finance Minister, is around 14 per cent of the GDP and if not reduced immediately will spiral to new levels. The government has resolved to eliminate subsidies in accordance with dismantling of the administered price mechanism (APM) by 2002.

The government is committed to reducing the price differential between diesel and kerosene. It has expressed concern over burgeoning subsidies on cooking gas and kerosene which account for Rs 17,000 crore as against Rs 12,000 estimated in November last.

In the less developed countries like Pakistan, Sri Lanka and Bangladesh not only are diesel prices low but the difference between these and kerosene prices is very marginal. As international oil prices rise, India’s oil pool deficit will cross Rs 60,000 crore in the current fiscal from Rs 24,000 crore in 1998-99.

Inflation is most likely to peak in the future. A look at the latest figures go to show that the inflation monster has already starting baring its fangs.

For weeks the inflation was stable. But a spurt in the prices of fuel and no roll back in subsidies has pushed inflation to over 5 per cent.

Inflation is a very strong monetary controller. It has alarmed every country. A slight rise in inflation sends all heads rolling and every macro indicator is closely watched. Inflation is closely associated with the employment factor in the economy. It is such a powerful tool that only countries with an inflation rate of less than three per cant could qualify to join the European Union.

This is proof enough of the importance of inflation rate in gauging a country’s performance.

In India, we have such a large unorganised sector that it is very difficult to monitor the price rise and its effect on the employment levels.

India has achieved a lot by way of development. But it still lacks proper financial infrastructure and accountability standards which are very essential if accuracy is to be maintained. Today Indian banking and financial institutions standards are the best in the world. But what about the high per centage of rural poor that still access the unorganised markets for their source of funds? How does one take into account these transactions, for which data is not available, in calculating the amount of money with the public?

The government and RBI authorities spend sleepless nights studying the underlying factors that are fuelling inflation in the economy and not contributing to growth in the desired manner. They have suddenly realised that it is not only monetary expansion but the definition of inflation and its index that is creating misunderstandings and thus hindering the calculation of the true level of price increase.

So what they have invented is a new term of jargon -- CORE INFLATION. This will give an idea of how the inflation rate would move along the economy’s long term growth path if there were no major shocks to the economy.

It would try and establish a correlation between underlying cost and demand conditions that affect inflation when output is at its normal level. Measuring inflation this way would be more accurate as it would remove some of the volatile components in the index which are of temporary nature.

RBI has adopted what is statistically described as the weighted trimmed mean method which considers all commodities but removes only the fixed per centage of skewness of inflation from the WPI basket.

Core inflation reveals a better co-movement with the broad M3 growth than with actual inflation particularly in the year of supply side shocks in the economy. But this concept is still at a preliminary stage and further statistical inputs would have to be gathered to make it a part of the monetary policy.

In India, given the role of supply side factors in the recent inflation, an estimate of the core rate of inflation could also be useful as an indicator of the movement of underlying inflation. However there have been very few empirical studies in the Indian context.

Estimates of core inflation are very sensitive to factors such as commodity basket and weight structure.

The broadest measure of core inflation for the Indian economy could be given by an index constructed after excluding administered prices from the WPI and the commodities which are significantly influenced by supply shocks.

The commodities that could be considered for exclusion from the WPI for deriving such a measure of core inflation are the administered price items and the primary food and non food articles.

By this criterion the commodities excluded constitute about 47 per cent of the total weight of WPI. The core inflation measured under this criterion is estimated to have declined to 1. 7 per cent in 1999-2000 from 4. 8 per cent in 1998-99. But considering the vast number of items that have to be dropped it is uncertain whether core inflation will be able to provide a true picture of the price levels and living standards in the economy.

The RBI, in its latest Monetary report, has cautioned the government against frequent changes in the Minimum Support Price (MSP) which tends to create inflationary pressures. Hike in prices of rice, wheat, sugar and paddy which have a very high weightage in the food price index, fuels inflation and rises inflationary expectations in the economy.

A look at the MSP since 1995-96 shows that rate of increase in MSP has been generally higher than the annual rate of inflation.

However food prices have been stable since 1999-2000 and hence overall inflation rate has remained subdued. With agriculture performing fairly well and buffer food grains stocks at 5 million tonnes inflation should be fairly under control.

Well the million dollar question is what level of inflation will the Indian economy be able to absorb and what will be its effect on growth indicators?

But history should not repeat itself. Forces beyond government control should be prevented from getting into the limelight once again and eating into the already poor standards of living of the masses.