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#TrueInflation : The actual Inflation that hits you !

January 16, 2014

Reserve Bank of India (RBI) wants to reduce Retail Inflation to 4%. RBI wants to include inflation as a benchmark in Monetary Policy. In this era of mysteriously high inflation, we should know what is the true inflation impacting us ? Know your #TrueInflation... 

The typical inflation metrics that we hear everyday in India are WPI and CPI. From WPI and CPI figures, we have to estimate how our cost of living is changing. But, did you ever wonder what is the actual inflation that hits us ? Lets call this actual inflation affecting us as #TrueInflation

#TrueInflation can provide a much realistic clarity on how our cost of living is changing each day ? #TrueInflation can act as an important benchmark for annual increments at your day job in India.

 

Before, I get to estimating #TrueInflation, lets take a minute to understand how inflation is calculated ?

Inflation in India is made up of a basket of commodities whose prices are tracked on a monthly basis. Every commodity has a weight to the overall inflation basket. Take for example ‘Potato’ has a weight of 0.20% in the overall inflation basket and ‘Pig Iron’ has a weight of 0.39%.

Now, when the prices of commodities move, the overall inflation index is adjusted to the extent of weights of the commodities. So, if potato price has increased from Rs. 20/Kg to Rs. 24/Kg, then the price increase of potato [(24-20)/20] = 20% is multiplied with its weight 0.20%, making the net impact on overall inflation as 20% * 0.20% = 0.04%. Whereas if the price of pig iron has increased from Rs. 20,000/MT to Rs. 25,500/MT, the net impact on overall inflation will be 0.11%.

 

The point here is that the current inflation metrics (WPI or CPI) are representation of price movements in economy at large. These metrics fail to represent the specific inflation impact to any class of society or individual. Clearly a person working as ‘bank officer in a private bank’ will not be affected by the price change of 'pig iron'. Hence, the weights to compute #TrueInflation need to be customized as per an individuals spending pattern.

To be able to compute #TrueInflation we will need to understand which commodities affect our daily life. I am planning to create a #TrueInflation Calculator & Tracker, which will be customizable depending upon anyone’s lifestyle. But, for now lets take the example of bank officer.

I have tried to list down her monthly expenses. Some of the expenses are done on a longer horizon, which are brought down to monthly level. Below table describes the her monthly expense pattern

Expense Category

Monthly Expense Amount (in Rs.)

Grocery - Food Items

 5,000

Grocery - Non Food Items (Toothpaste, Shampoo, Perfumes etc.)

 5,000

Clothes & Shoes (12000 once every 6 months)

 2,000

Partying / Restaurants / Bars

 5,000

Holiday (Hotels+Flights; 24000 once an year)

 2,000

Utility Bills (Phone / Electricity / LPG)

 2,500

Computer Electronics (Laptop / Smartphone; 48000 once every 3 years)

 1,333

Home Electronics (AC / Fridge / TV etc.; 36000 once every 3 years)

 1,000

Medicines

 600

Jewellery (36000 once a year)

 3,000

Fuel (Diesel)

 4,000

 

Given the above expense pattern, the #TrueInflation she would have faced in December 2013 would have been 4.89% y-o-y. This inflation is relatively much lower compared to the reported 6.16% of WPI and 9.87% of CPI for December 2013. This is because the prices of her usage items have dropped more significantly than rest of the items in large WPI / CPI basket. Below graphic shows a chart of how #TrueInflation has moved compared to WPI & CPI over last 4 years.

 

 

It is evident that there is vast variation in WPI / CPI and #TrueInflation. And noway we can correlate these three. For the last 4 years, WPI and CPI have averaged (CAGR) 7.66% and 9.24% respectively. #TrueInflation for her has averaged at 10.52% for last 4 years. So, if her annual salary increment at her day job had been more than 10.52%, then she is in-money, else her expenses are becoming dearer faster than her increment. Another point of view: typical Fixed Deposit rates in India hover between 9%-10%. So, if she had parked her funds in FD over last four years, then instead of a wealth build-up, actually her wealth had deteriorated. Hence, it is very important to know whats the #TrueInflation hitting us !

Data has been collected from Government of India's published commodities price information

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