Inflation – more than just a number!

The CPI data (or inflation number) for the month of January is due out next week. Mainstream & digital media devote substantial amounts of editorial space to this figure; bond yields move in reaction to this print; the RBI monetary policy is hinged on how this figure has moved on a monthly basis and most importantly, how it is expected to move in the future; the amount of foreign inflows are to a certain extent determined by this figure. Retail inflation had touched an all time high of 12.7% in November 2013 and reached a low of 1.54% in June 2017. The last data for December 2017 was at 5.21%.

What does this number mean and how does it impact us? It is a measure of calculating price changes for a predetermined basket of goods and services and is usually used to assess changes in cost of living. Does this mean that our cost of living had increased by 5.21% in December? Both yes and no. Yes, because the CPI data of 5.21% is a combined figure for price changes across categories and across rural and urban households and hence, an average figure for the whole country. And no, for the following reasons.

1) The rural inflation was at 5.27% while urban inflation was at 5.07%. Hence, for people living in urban areas, the change in prices was 0.20% lower than in rural areas.

2) The cost of living across states is also different. For example, Maharashtra’s CPI was 5.01% and Uttar Pradesh had a CPI of 4.18% with appropriate weights used to arrive at the combined CPI figure.

3) Most importantly, the weights assigned to different categories in the CPI basket may not match those in your basket of goods and services. The weights in the CPI basket are as follows:

Major Groups Weights
Food, beverages & tobacco 48.24
Fuel & Light 6.84
Housing 10.07
Clothing & Footwear 6.53
Miscellaneous 28.32

If you take a typical DINK (double-income-no-kids)in the city of Mumbai, the weights are as follows:

Major Groups Weights
Housing+help              43.48
Conveyance              17.39
Utilities                 4.35
Food                 8.70
Entertainment              17.39
Clothing & footwear                 8.70

And it’s not just the composition of the index that will be different from your own personal basket.The measurement also does not take into account the shift in consumption curves when household income increases.

For example, take the cost of watching a movie on a single screen vs at a multiplex which is the more prevalent mode of screening in big metros or the cost of shopping from the unorganised vs the organised sector or the switch in transportation mode from bus/trains to flights or the cost of a regular cable connection vs Netflix, Amazon Prime, etc. or the cost of eating out at low cost jaunts vs at more established and popular places or the cost of travelling within the city by public transport vs byOla/ Uber or the cost of getting treated by a doctor at a local clinic vs the cost of visiting a private hospital; etc.

The point I’m trying to make is that while the inflation number is a key indicator in assessing the cost of living on an average in the country, the number will be different for each one depending on the lifestyle and consumption patterns.

This has a very important implication on the way we have to save and invest. Most of us are familiar with the concept of earning returns that are greater than the rate of inflation or real returns. The rate on a 1 year fixed deposit is 7.40% and even if we go by the simple average inflation of 4.36% for the period of Jan- Dec 2017, the real return is 3.04% before tax. Is this a return that you’re comfortable earning?





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