Consumer price index or CPI is a metric that is used to measure inflation. To be specific, CPI measures retail inflation by collecting data on the prices of goods and services that are consumed by the retail population of the country. CPI meaning refers to an increase in the price level of a selected basket of goods and services over a select period of time.
CPI measures the change in the price level of goods consumed by retail consumers, who are on the demand side of the economy. For the same reason, it can be interpreted that CPI measures the purchasing power of an economy’s currency.
CPI is calculated for a fixed basket of goods and services that may or may not be altered by the government from time to time. It is a macroeconomic indicator that measures inflation. It is used as an essential economic tool by central and state governments, the Reserve Bank of India, which is the central bank of our country for maintaining money supply, price stability.
What does CPI tell?
In a nutshell, these are a few things that CPI index interprets:
- Cost of living
- The purchasing power of consumers
- The expensiveness of different articles that consumers buy and services that are availed
- Value of the Indian rupee
How is CPI calculated in India?
Measuring the price of a basket of goods and services that an average Indian consumes is a tedious process. This just does not include food, clothing. This will consist of transportation, medical care, electricity, education and almost everything that requires an expenditure of money.
Consumer price index is calculated as a percentage. It is a comparison of the general price level in the markets in a particular time period from a time frame in the past. This is known as the base year. CPI, therefore, is calculated by referring to a base year which is a benchmark.
The base year is monitored by the Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation (Mospi) and changes from time to time. Last, the base year was shifted to 2012 from 2010. This was effective from January 2015 onwards.
Items for the CPI basket of goods and services classified across categories. Few of the categories are; food and beverages, clothing, housing, fuel and light, recreation and etc. All categories are assigned weights This data is collected by the National Statistics Office (NSO) from 1181 village markets and 1114 urban markets distributed over 310 towns/cities of the country.
Currently, the consumer price index (CPI) is calculated by taking into consideration 299 items.
The formula for calculating CPI index is:
(Cost of a fixed basket of goods and services in the current year/cost of a fixed basket of goods and services in the base year) * 100
Interplay between CPI and Repo Rates
CPI is an essential tool for RBI as it looks after the monetary policies of the country. The framework by RBI requires it to keep the inflation rate around 4% however it can fluctuate anywhere between 2% and 6%. The primary motive of RBI is inflation control, while it may change from time to time depending on the decision of the monetary policy committee. Knowing what is CPI and how much is the impact becomes important for the central bank.
The MPC holds its meeting to decide the repo rate in the economy. Repo rates are decided in tandem with the inflation rate of the economy.
Say the inflation in the economy is rising. This means that the general price level prevailing in the market is rising. In such a situation, to arrest the inflation, the central bank would want to reduce the money supply in the economy. For this RBI may increase repo rates, which will make it difficult for the banks to borrow money from the RBI, ultimately reducing liquidity in the economy.
Therefore, often inflation is the deciding factor for RBI’s monetary policy.
The interplay between inflation and investment
Calculating inflation-adjusted returns is extremely important because it tells the real value of an investment and if the money has grown in real terms or not. Say your investment gave you 3% returns per annum over a period of time and the value of money, which is inflation, also rose 3.5%; net-net your investment’s returns get nullified. Reason being, the value of money also rose.
Hence, it is important to spot inflation-beating investment instruments.
If inflation is going up and it can be seen in CPI climbing up, it means that the same Rs 100 will be able to buy a lesser number of goods tomorrow that it could today. Value of money has risen over the years, and it is a general function of the economy. The same 10 paise that could afford a big basket of goods in the 1940s-50s is not even a valid denomination in India in today’s times. While this is a broader idea of inflation, an increase in the general level of prices is experienced by people on a day to day basis. Whether one is going to buy vegetables, availing the services of an IT firm or even making an investment into stocks, mutual funds and likewise. CPI is a metric that can be used by anyone from any walk of life: investor, trader, consumer, businessman, farmer, and the list is endless. Since CPI decides the value of money, it sets the base for any transaction.