Changes and movement in prices influence buying and selling decisions, and thus the economic scenario. Hence the government, businesses, producers and consumers keep a constant check on prices. However, given the large number of items that are sold and purchased every day, it is difficult to keep track of all of them.
That is where price indices come in. They give a sense of the overall direction and trend in prices. These indices are available for different sectors and for different groups of people.
There are indices based on prices in different markets or at different points of sales. Of the many indices, two are of critical importance. The first is the Wholesale Price Index (WPI), which is based on the price prevailing in the wholesale markets or the price at which bulk transactions are made. The other is the Consumer Price Index (CPI), which is based on the final prices of goods at the retail level. Both these indices are the weighted averages of prices of a specified set of goods and services. The WPI is compiled and published by Office of the Economic Advisor on a weekly basis while the CPI is compiled and published by the Labour Bureau on a monthly basis in India. The CPI is published for rural, agricultural and industrial workers.
The use of price indices
These indices are used for various purposes, including for forecasting in businesses, used by organizations and institutions for their analysis, and by the RBI and the government of India to frame monetary and fiscal policy, etc. The WPI is used to measure inflation in India because of the non-availability of appropriate CPI. It is used to deflate national income to calculate real output in the economy. Also exchange rates are often adjusted on the basis of WPI. For example, (hypothetical since India has flexible exchange rate) suppose the WPI index in India rises by certain points (inflation). In order to maintain the purchasing power of the rupee vis-a-vis other currencies, the rupee is depreciated. This would keep the price of Indian goods same in terms of foreign currency, in spite of the inflation in India.
The cost of projects, price of supply of goods based on future contracts are often subject to change with these indices. As these indices change, cost and supply prices are changed accordingly. For example, an increase in the WPI may lead to increase in contract price of goods. This role of indices will increase substantially in the future as economy matures and as new markets develop for contractual trading. Also, often the wages and salaries are indexed to inflation.
Problems with WPI
However, although the WPI is used in India for various purposes, there are flaws in it. For many commodities like cars, wholesale markets may not exist. Also with increased competition, prices based on costs, and the reduced role of government in trading of goods and services, it is difficult to obtain prices and price data from private producers. The WPI doesn’t take the price of services into consideration, which now accounts for 60 percent of the GDP. Also, it is too general and cannot be used for specific purposes. For example, if an individual wants to know the trends in office stationery products, then WPI may not capture the correct or complete picture. Some commodities may have higher weights during a particular period and may not be consumed during other. For example, woolen textiles are part of the consumption basket only for four months in a city like Delhi. So a constant revision of weights is required in this regard. Another problem is that the share of expenditure of commodities may change overtime. For instance, the expenditure on computers, which were seldomly available before 1990s but now have a significant share in the expenditure of an urban Indian. So the weights of these indices need to be changed over time.
WPI and CPI in India
Inflation in India, measured by WPI, reached 12.9% on August 2, 2008 but fell sharply to 0.3% in March 2009 and negative in June 2009. The reason for such high volatility was the primarily fluctuation in international commodity prices. However, unlike WPI-based inflation, CPI-based inflation remained high. It did increase with the WPI but did not come down proportionately when wholesale prices fell. This indicates that intermediaries between consumers and wholesalers or retailers or both have not passed on the low-cost benefits to the customers and so have enjoyed increasing margins.
The graph clearly shows that for most of the time, the rate of growth of the CPI is more than the rate of growth of the WPI, except when there are steep rises in the WPI during 2006 and 2008. This may be due to the inability of retailers or intermediaries to pass on the increasing cost to the consumers so quickly. This may also point out towards the existence of competition in the markets.
Businesses Strategies and Price Indices
These indices help businesses and can prove to be an effective analytical tool for them. These trends affect the economic policies and monetary policies of the government and RBI respectively. High inflation rates are often followed by tight monetary policies. In India, the WPI is related to interest rates as inflation is measured on the basis of the WPI. High inflation rates may point towards increasing interest rates. However, other factors also come into play while determining interest rates but inflation is a major one.
These indices play a role in affecting sentiments. Low inflation rates may lead to a sentiment where investments financed through loans are deferred because of the expectation of lower interest rates in the future. Certain expectations are formed based on the effects on overall economy due to movements in these indices. For example, high inflation rates create a gloomy sentiment about the economy and people generally tend to defer investments in that case. Also, consumers tend to defer their heavy expenditures during inflation due to expectancy of fall in prices. For instance, housing expenditure. However, other day-to-day expenditures like grocery, energy, etc are generally not affected due to changes in these indices.
It should be noted that falling inflation never means that prices are falling. Only negative inflation or a fall in these indices imply that prices are falling. Falling inflation (positive) or decreasing rate of increase in these indices only imply that prices are rising at a slower pace. So falling inflation for consumer does not mean that he/she has to pay a lower price in the future.
These indices also give insights whether holding an asset is justifiable or not. For example, if an asset price rise is less than the inflation in the economy, then this may point out towards erosion of purchasing power of the asset holder. In other words this means that an asset holder may not be able to purchase the same quantity of goods in the next period if price rise in asset is proportionately less than the rise in these indices by selling that asset. So investment in assets must be made keeping this in mind. An absolute increase in the price of the asset does not definitely mean that the asset holder has gained in real terms.
Also movements or changes in these indices affect the futures market. High inflation rate and increasing trend may point towards higher price in future and hence higher prices of futures contracts. Large movements or fluctuations in these indices often open up the opportunity for arbitrage, which is making profit due to price differences in two markets (here different markets refer to future and spot market).
If trends are analyzed (in graph also) then it would be clear that large margins or the gap between the rate of increase of WPI and CPI could not be maintained for a long period of time because of the existence of competition in most of the markets. Trends indicate that a fall in WPI inflation is often followed by a fall in CPI inflation. So if the current situation is assessed, then it can be the case that retailers or intermediaries would see a squeeze in their margins as the inflation gap between the WPI and the CPI will eventually get reduced. Also, CPI inflation has already started coming down. At the same time an increasing gap between the WPI and the CPI inflation may attract interference by the government in some form of regulations or required policy changes to check such trends.
So these indices at times may be inconsistent, may not guarantee fulfillment of requirements of an individual and analysis based on these might not be complete or correct. However, these indices provide useful tools for analysis and some conclusions could be drawn based on these.
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