The Wholesale Price Index (WPI) revealed last week that the inflation rate was 12.44 per cent, a claim to precision and accuracy that is belied by the many things that are wrong with the way in which the index is computed. It is a serious question whether the best available data and analytical capabilities are being brought to bear in generating an index, on whose weekly movement the actions of both market participants and policy-makers depend. As the inflation numbers have surged into dangerous territory, there are clear instances of the weaknesses in the way in which the index is calculated, distorting the true number, which may be above or below what the index itself shows. Prices of commodities, which have risen rapidly, are adjusted with a lag, causing a disproportionate spurt in the index. While the index is supposed to capture market transactions, the prices of several commodities do not reflect the market reality. There are other infirmities too. The bottom line is that, if the existing index does not capture the underlying reality in price movements across the economy, it needs to be replaced with something better.
It is not that attempts along these lines have not been made. A few years ago, the government initiated the design of a Producer Price Index (PPI), which has a number of advantages over the WPI in accurately measuring the inflation rate in the economy. To place this in context, the best measure of inflation would be the GDP deflator, or the price index that converts GDP at constant prices into GDP at current prices. Since it mirrors the basket of goods and services measured in GDP, it captures the full range of price movements in the economy. Unfortunately, the GDP deflator comes out with too much of a lag to be able to respond effectively to changes in the inflation rate. For instance, the deflator for the April-June 2008 quarter, which will capture the dramatic developments on the price front during that period, will become available only on August 31. What the PPI would do is to balance the high frequency and short time lag of the WPI with the width of coverage of the GDP deflator. Because it is not dependent on the observation of market transactions, as the WPI is, it can cover a range of goods and (particularly) services not transacted in traditional wholesale markets. Price information is sourced directly from an identified set of producers of the entire list of goods and services included in the GDP calculations and the selling prices for defined units is obtained from them on a relatively high-frequency basis. For the Indian economy, in which services are so important, this approach would have filled a huge vacuum, besides making up for some of the other flaws of the WPI.
Unfortunately, this process seems to have stalled. Even as the GDP series was updated with weights for different activities being set to the base year 1999-00, the WPI (along with its companion, the Index of Industrial Production) still languishes with a base year of 1993-94. The dramatic changes in the Indian economy since then have simply not been introduced into two of the most critical indices. The country’s decision-makers surely deserve better. The issues standing in the way of a new index must be resolved as quickly as possible.
