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Will new model to gauge inflation work?
Thu, 19 Jul Pre-Open

The steep inflation rate has been the bane of contention for the Reserve Bank of India (RBI) over the past few years. The central bank raised interest rates 13 times in response to higher inflation, but to little avail. Subsequently it cut rates by 0.5%. But since then has refrained from further easing in light of inflationary pressure. But, is the inflation data actually representative? Now the RBI has a different trick up its sleeve to help determine price levels.

The RBI believes that the current inflation indicator, the wholesale price index (WPI), does not accurately capture the price movement of prices. The metric is a hybrid of consumer and producer price quotes. The prices of sellers and purchasers differ due to government subsidies, sales and excise taxes and distribution costs.

Thus, the RBI governor, Dr. D Subbarao believes that India should move towards developing and using a producer price index (PPI) to gauge inflation more accurately. This will help measure the average change in prices of domestic goods and services over time. The central bank is currently facing a challenge in assessing inflation trends. While WPI has shown easing trends recently, the Consumer Price Index (CPI) has been moving upwards. In May, the rise in WPI over the year was 7.25%, while the new composite CPI was at 10.36%. Core inflation (excluding energy and food) had stabilised at around 5% in recent months, however a reading over 3 years may be more accurate for the same.

Now with regards to India's growth potential, Subbarao believes that with low and stable inflation, the rate may have fallen to 7.5%, from the post-crisis level of 8%. Potential growth rate is the rate at which an economy can grow in the medium-term without stoking inflation. However, assessing this potential growth rate remains a challenge. The estimate could be vulnerable because of the huge revision in GDP data, uncertainty about productivity growth, etc. Plus, there is a lack of comprehensive data on employment numbers, which may further undermine the readings.

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Jul 21, 2012

Only time will tell, whether it will work or not

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