Inflation is the sweet poison

Constant price rises lead to wealth erosion and could reduce your purchasing power.

For commoners, inflation is always a reason to worry as it denudes one's purchasing power. If price increases and income stays unchanged, consumption takes a hit.

This is so because higher prices would entail higher expenditure for the same basket of commodities and services. The choice then is to either reduce consumption, which may not be possible or more likely reduce savings in order to meet the consumption requirement. But, which inflation rate are we talking about?

Inflation is defined as the percentage increase in prices of a basket of goods and services. It can be looked at two levels: the first is at the wholesale level wherein the wholesale prices are reckoned for a basket of goods.

The other is at the retail level where the prices at the consumer's end are calculated. What is interesting here is that the composition of the basket varies significantly in both the cases and the resulting inflation numbers are quite different. 

COMPOSITION OF CPI (ALL INDIA)
	UNME	IW	AL	RL
Food, beverages and tobacco	47	60	73	70
Cereals	11	21	41	38
Milk	9	7	4	4
Edible oils	4	5	4	4
Beverages	6	6	2	3
Fuel and light	16	9	-	-
Clothing and footwear	7	9	7	10
Miscellaneous	24	16	12	12
Transport	5	3	2	2
Education	5	2	0.5	0.5
Medical	3	3	4	4
UNME: Urban Non-manual employees;  IW: Industrial workers; AL; Agricultural labourers; RL: Rural labourers

As a salary earner, which index should you be looking at? While the WPI or Wholesale Price Index is what is publicised every Friday which for all purposes has become the benchmark inflation rate, you will realise that this index is not representative of your consumption basket.

Oilseeds, fibres, machinery, transport equipment, metals, chemicals etc all feature in this basket but you would not buy these things in the market and you are affected only very indirectly.

On the other hand, services such as transportation, housing, food products etc tend to dominate our expenditure and would be of concern to us. Therefore, the CPI becomes relevant.

The CPI is again of different varieties. They vary depending on the type of person you are: industrial worker, urban non-manual labourer, rural labourer or agricultural labourer.

Each of these categories has a unique consumption basket as given in Table 1. Agricultural workers, for example do not spend on housing or transportation and spend more on medical facilitates which are rare in these areas.

Therefore, one needs to identify the category of workers we come closest to resembling. Further, there are CPI indices for different centres as prices vary between different centres, especially of food articles as well as housing and transport.

As a salaried employee, one would have to identify oneself with the group and then reckon the rate of inflation. Normally salaried employees in the organised sector are indexed via their dearness allowance (DA) with the CPI-IW or CPI-UNME. Tere is hence cover available for inflation protection in these cases.

Inflation again is reckoned in two ways once an index is chosen. The first is on point-to-point basis which is the quickest indicator wherein the indices at two points of time are compared with one another.

However, the more accurate measure is the average inflation rate which compares the average of the indices over two periods. This measure is free from base year effects which is quite prominent in case of the point-to-point measure.

The average inflation rates have varied for all these categories. Prices at the retail end have tended to rise faster than the wholesale prices with the agricultural and rural labourers facing the highest inflation rates. This comes out from the fact that these workers have a higher share of food products which have risen at the WPI level at the highest rate of 7.3%.

As a salary earner one should focus more on the inflation rate for industrial workers especially if we are residing in the metro cities or the UNME index which is also closer to this section of people.

The rural people have confronted higher rates as their basket is weighed in favour of food products with a weight of 70 per cent. Higher retail prices have affected their purchasing power, and there is less recourse to wage adjustments in this situation.

Therefore, while the affect on real wages and salaries is disparate, the organised sector tends to be better covered against higher inflation through adjustments in salaries than the unorganised sector.

This is done through the wage negotiations which are then factored into the dearness allowance. Where remuneration is not linked with DA, annual salary hikes are benchmarked against CPI inflation.

Further, rural/agricultural labourers, to the extent that they are also farmers, would be partially buffered through higher incomes in the form of higher prices of agricultural products.

But the unorganised sector as well as rural labourers who are wage earners essentially would be hard hit by the current inflation, which for the last 11 months has been over 7 per cent- almost 2 per cent higher than the WPI inflation. This is also indicative of the higher increase in prices at the retail level, ostensibly through the value chain costs.

(The writer is Chief Economist, NCDEX Ltd and the views expressed are his own)