For May 2021, inflation as measured by the consumer price index (CPI) stood at 6.3%. It was the highest since November 2020, when it had stood at 6.93%.
Of course, this has been splashed all over the media since yesterday evening when the figures were published. But do you ever sit back and think about what does inflation really mean for you? (I mean why would anyone sit back and think about inflation, but nonetheless please humour me for a bit). If you haven’t, let me set the cat among the pigeons.
1) The government publishes inflation as measured by the CPI every month. So, when it says inflation in May 2021 stood at 6.3%, does it mean that inflation for you, dear reader, also stood at 6.3%? Or that you paid 6.3% more for things on an average in May 2021 than you did in May 2020? Have you ever thought about this?
The CPI consists of many items whose prices are regularly tracked by the government (specifically, by the ministry of statistics and programme implementation). All these items have a certain weight in the index.
So, food items overall have a weight of 39.06% of the index. The assumption here is that the average Indian makes nearly two-fifths of his expenditure every month on food.
If you are reading this, chances are your expenditure on food every month as a proportion of your total expenditure, is lower than 39.06%. I say this simply because you are reading this in English, and anyone who can read English in India, is likely to be better off than an average Indian.
Hence, inflation of 6.3%, isn’t your rate of inflation. It can be higher or lower than this, depending on stuff you regularly consume.
Take the case of petrol prices. They have risen by 62.28% in the last one year, if we look at the inflation as measured by the wholesale price index (this data as per inflation as measured by CPI, hasn’t been published in the recent months).
In inflation as measured by the wholesale price index, petrol prices have a weight of 1.6%. In inflation as measured by CPI, they have a weight of 2.19%. Your expenditure on petrol as a part of your overall expenditure, is likely to be more than this.
Also, on a slightly different note, rising petrol, diesel and gas prices, feed into food prices, because food needs to be moved from where it is produced to where it is consumed.
2) As people earn more, their spending on food as a proportion of their overall spending comes down. Also, within the food basket, spending on cereals comes down and spending on foods which have protein (eggs, pulses, meat, etc.), goes up. The spending on milk also goes up.
When it comes to the CPI, this can simply be gauged from the fact that the weightage that food has in the urban part of the CPI is much lower than the rural one. When it comes to urban India, the weightage of food items in the CPI stands at 29.62%. In case of rural India, the weightage is much higher at 47.25%.
This is primarily because the average urban Indian earns more than an average rural Indian and hence, incurs a lower proportion of the overall expenditure on food.
Of course, as people earn more, their spending on items other than food increases and that starts to matter more. Even here the stuff that CPI measures and your regular consumption basket may not intersect. Let’s take the case of household goods and services, a heading under CPI.
This heading keeps track of inflation of bedsteads, almirahs, dressing tables, chairs, furniture, bathroom and sanitary equipment, bedsheets, mosquito nets, air conditioners, sewing machines (yes, still!), washing machines, invertors, refrigerators, etc. In May 2021, the inflation for all these items overall stood at 3.89%.
Here is the thing. While these items are important in the overall scheme of comfortable middle class living, they do not have any impact on regular expenditure, given that they are one-off purchases. Hence, they don’t impact your regular consumption and, in the process, your regular inflation.
But this is a point that is not important for the government. The government is trying to figure out the rate of inflation for the society at large, so that this can help in other ways, like figuring out the adequate level of interest rates for one.
3) But there is a flip side to the above point as well. The health inflation in the last one year has been 8.44%. Now anyone who has had to deal with India’s urban private health system in the last one year, will tell you that is a load of bunkum. Prices have gone through the roof and the rate of inflation doesn’t really capture it.
Of course, going to the hospital is also not something that most people do regularly (I am not talking about basic visits to a personal physician here). Hence, anyone who has had to spend some time in a hospital this year, or has had to finance a close one’s stay, would have ended up spending a lot of money and paid significantly higher prices than last year.
So, one-off expenditures during a particular year can really make a mess of your finances, and that is something the inflation as measured by CPI doesn’t really capture.
Also, on a slightly different note, as Madan Sabnavis, the Chief Economist of CARE Ratings puts it: “Problem with most of the inflation numbers relating to personal care, health, recreation, transport is that once prices are increased they would not come down and hence becomes a new base.”
The point being that inflation measures the rate of increase in price over a period of one year. Hence, the annual inflation itself may not be high, but that doesn’t necessarily mean that things are not expensive.
4) Different states have different rates of inflation in different years. In 2019-20, among large states, Kerala had the highest rate of inflation at 6.1%. Bihar had the lowest at 2.2%.
Source: Reserve Bank of India.
What does this mean? It means that the inflation you experience also depends on which part of the country you are in and the inflationary pressures it is experiencing during a particular year. Of course, within a state, whether you are in an urban area, or a rural one, also makes a difference.
5) Clearly, the official rate of inflation doesn’t tell you much about anything. Hence, what can you do about it? First and foremost, you need to do an expenditure audit and figure out the things you spend your money on regularly (you will be surprised). This shouldn’t be so difficult if you make purchases online or make payments digitally or use plastic money.
The important point here is to identify the most important items and not every possible one, and keep track of expenditure on the important items, over a period. A simpler method is to just keep track of regular monthly expenditure and that too can give you some inkling which way your finances are headed, and whether you are spending more or less than you were doing in the past.
This is not a totally foolproof and methodical system but more of a crude method to get around the uselessness of the official rate of inflation at an individual level, when it comes to consumption. Of course, there are other implications which I do keep talking about.