Inflation is the most worrisome factor in the Indian economy. Of all the statistics that are keenly watched in the economy, the state of the price level is the one that grabs news headlines. Quite rightly so! For it is what affects the common man the most. For the Reserve Bank of India (RBI), the trajectory of inflation is the single most important factor for determining monetary policy. Thus the reliability of inflation data should be of paramount importance. Unfortunately, India does not do very well in this regard.
Inflation in India is measured by the Wholesale Price Index (WPI) and the Consumer Price Index (CPI). However, the two do not always move in tandem. Out of the two, the WPI is clearly the measure that is flawed. It is comprised of a basket of commodities and manufactured goods. There is no services component in the WPI. This is despite the fact that the services sector contributes almost 60% of GDP. This is one of the reasons why the RBI mostly uses the CPI while setting interest rates. But things may change for the better soon.
The government is currently working on developing a suitable replacement for the WPI in FY16. The new index called the Producer Price Index (PPI) will be far more comprehensive than the WPI. Not only will the PPI include the service sector but it will also solve the problem arising out of various taxes in the country. India's complex indirect taxation structure adds to the base price of various goods produced in the country. This creates problems while calculating the WPI. However, the new PPI will measure changes only in the base price which will help to standardize the measurement across India. This is the standard used across the world.
This is certainly a welcome move by the government. It may be recalled that the previous government was constantly at loggerheads with the RBI. One of the reasons was that the government wanted the RBI to focus on the WPI number while fixing interest rates but the RBI did not consider the WPI to be reliable. Once the PPI is introduced, the RBI will have a very holistic picture of the price level in the economy. Thus, it will be able to conduct its monetary policy in a more effective manner. Hopefully, this will eventually lead to a better control over inflation in the long term.