New method to calculate inflation now

Amid spiralling prices of essential commodities in the country, the government is planning to revamp the method for measuring inflation with the help of World Bank's technical assistance.

Moves are afoot in the government to come up with a more realistic way of measuring inflation through a Producers Price Index (PPI) that would replace Whole Price Index (WPI).

A committee has been set up under eminent economist and Planning Commission member, Abhijit Sen to come up with a PPI with a base year of 2000-01, government sources said, adding that the World Bank's expertise is being sought for drawing up the methodology, used by most of the advanced nations, within 2-3 years.

The development assumes significance in the face of spiralling inflation based on WPI now at 7.94 per cent due to the impact of rise in prices of oil, steel and other items in international market.

Although Finance Minister P Chidambaram slashed duties on a number of items to keep domestic price level stable, sources said inflation based on WPI shows wide divergence from that based on Consumer Price Index, and hence there is a strong case to relook at the methodology of measuring inflation and come up with a more realistic index.

"WPI measures the prices of both inputs and outputs. The index also includes taxes paid by producers. But PPI would be based on prices of only outputs excluding intermediate costs and taxes," a senior government official said.

At present, WPI is calculated on the basis of prices of agriculture produce at the mandi level, while manufactured product prices are taken from major markets.

However, PPI would be calculated on the basis of prices of agriculture products at the farm level while it would be ex-factory prices for manufactured products.

Collection the price quotes at the producers' level every week for coming up with a point-to-point inflation would be uphill task for government, admits officials.

But it is not impossible, as such method is used for drawing up the GDP deflator. The nominal value of GDP is divided by the deflator (the average inflation rate) to arrive at the real GDP.

"It will take time to put in place PPI. The government will have to collect data for at least five years. There will be a pilot project and depending on its success, it will be adopted," an official said.

Manufactured and agriculture products would first be considered for the PPI. This will take care of about 50 per cent of the GDP.

Prices of services would eventually be incorporated in the PPI, the official said.

The proposal to shift from WPI to PPI comes after the first meeting of Cabinet Committee of Prices chaired by Prime Minister Manmohan Singh a few days ago.

There is a debate in the government circles about the wide divergence of WPI and CPI-based inflation, and ways to come up with a more realistic measure for prices.

PPI has been proposed by some of the key economic ministries to capture the exact rise in prices of commodities and filter off other costs that are added on to the products before they are bought by consumers.