Inflation and IIP explained with examples

Inflation

Inflation is an economic concept that refers to an increase in the prices of goods and services, as well as a decrease in the value of money. It’s caused by a variety of factors, including changes in market conditions and government policies. 

Inflation can have both positive and negative impacts on an economy, depending on its severity.

An example of money losing its purchasing power will be if the cost of 1 KG of onion rises from Rs.15 to Rs.20, which is an indication of inflation. High levels of inflation can lead to economic uneasiness and can send bad signals to the market. 

Therefore, both Government and RBI strive to keep inflation within manageable limits by monitoring the respective inflation indices – a rise indicates rising inflation, while a decrease points towards cooling off.

Inflation can be measured in terms of two indices – the Wholesale Price Index (WPI) and the Consumer Price Index (CPI).

Wholesale Price Index (WPI) is a measure of the movement in prices at the wholesale level. It encompasses the fluctuations in cost when buying and selling wholesale. This metric is an easy and efficient way to ascertain inflation, although it does not take into account the consumer’s inflation experience.

The Consumer Price Index (CPI) is an important indicator of the impact of inflation on everyday family expenses like food, fuel and other commodities. 

To formulate the CPI index, the calculation is done in a detailed way, taking into consideration classifying of consumption across urban and rural regions, based on categories and subcategories. Finally, all these gauges are combined to arrive at the CPI that strongly reflects changes in prices at a retail level.

The precise calculation of CPI makes it an essential measure in analyzing the economy. The Ministry of Statistics and Programme Implementation (MOSPI) releases the CPI figures generally within the 2nd week of every month. The RBI’s task is to find a balance between inflation and interest rates, bearing in mind that low interest commonly leads to high inflation and vice versa.

Index of Industrial Production (IIP)

The Industrial Production Index is an indicator used to measure the general level of production in the industrial sector of an economy. It is calculated by a base-weighted combination of indices for the mining, manufacturing and electricity industries. 

The IIP measures output from factories, mines and utilities on a monthly basis, providing insights into the overall performance of the industrial sector.

The Ministry of Statistics and Programme Implementation (MOSPI) distributes data updated monthly along with inflation-related information. The reference point is colloquially referred to as the ‘base year’.

About 15 industries supply production information to the ministry, which collates it and produces an index number. An increase in the IIP is usually a sign of good economic activity and, therefore, a positive development for the markets. On the other hand, if the IIP drops, it suggests that production is not doing well and thus is indicative of negative impacts on the economy and markets.

Overall, when industrial production increases, the economy tends to benefit. However, a decrease in output can be a cause for concern. Over time, India has become increasingly industrialised, with the Index of Industrial Production playing a larger role.

The lower Index of Industrial Production puts strain on the Reserve Bank of India to reduce rates of interest, thus encouraging industrial credit with more affordable financing.