Tuesday, May 24, 2011

Core vs Headline Inflation

What is inflation? Why do we care so much about inflation? Inflation is a sustained increase in the overall level of prices. Since price stability is a key objective of monetary policy, central banks are obviously concerned with inflation. Prices of specific goods or services may go up or down relative to the prices of others reflecting changes in productivity or demand and supply conditions. But when the overall price level rises, it erodes the purchasing power of income, raises the cost of living and lowers the real value of savings. Savers, investors and financial intermediaries track closely the link between inflation and interest rate. The level of inflation is also critical in terms of maintaining competitiveness of domestic industry in a liberalized trading and market determined exchange rate regime. More importantly, it is the poor who are most vulnerable to inflation as they do not have any effective hedge against inflation. As Keynes said, "Inflation is the form of taxation which the public find hardest to evade." Thus, the issue of inflation and its measurement have always received lot of attention in India.

Currently, there are five different primary measures of inflation – the Wholesale Price Index (WPI) and four measures of the Consumer Price Index (CPI). In addition, Gross Domestic Product (GDP) deflator and Private Final Consumption Expenditure (PFCE) deflator from the National Accounts Statistics (NAS)
provide implicit economy-wide inflation estimate. The WPI is considered as the headline inflation measure because of its availability at high frequency.

While the WPI does not cover prices of services, CPIs are meant to reflect the cost of living conditions for a homogeneous group of consumers based on retail prices. Among the four measures of CPI, the CPI for Industrial workers (IW) has a broader coverage than the others – the CPI for agricultural labourers (AL), rural labourers (RL) and urban non-manual employees (UNME). In the organised sector, CPI-IW is used as a cost of living index

GDP deflator, on the other hand, is a comprehensive measure of inflation, implicitly derived from national accounts data as a ratio of GDP at current prices to constant prices. While it encompasses the entire spectrum of economic activities including services, it is available on a quarterly basis with a lag of two months since 1996. Moreover, national income aggregates extensively use WPI for deflating nominal price estimates to derive real price estimates.

Divergence between WPI and CPI

Why do WPI and CPIs differ? They differ in terms of their weighting pattern. First, food has a larger weight in CPI ranging from 46 per cent in CPI-IW to 69 per cent in CPI-AL whereas it has a weight of only 27 per cent3 in WPI. The CPIs are, therefore, more sensitive to changes in prices of food items. Second, the fuel group has a much higher weight in the WPI (14.2 per cent) than the CPIs (5.5 to 8.4 per cent). As a result, movement in international crude prices has a greater bearing on WPI than on the CPIs. Third, services are not covered under WPI while they are, to different degrees, covered under CPIs.
Consequently, service price inflation has a greater influence on CPIs.

More on inflation can be found here

Friday, May 13, 2011

Cast of Carry on Nifty Futures

Market opened at flat in the morning at 5480 levels, But as the news of Left thrown out from kerala and WB Market reacted in a positive way and moved till 5560 till 12:00. With Europe Opening in Positive and News of interviews related to more Reforms led the market to cross 5600 Levels and after more than one week NIFTY quoted at 15 points premium to Spot, which is good sign that people are buying.

By 3:00 Traders started to exit there positions to gain from 100 points rise and market cracked a bit , but what is surprising is the premium at which NIFTY is Quoting to SPOT at close

Nifty Futures were Quoting at 5580.85 at close while Spot is 5540 a 40 points premium which is never seen by me .Does it mean Market will go up in coming days? lets see how it unfolds in coming days.

But what is surprising more is the Cost of Carry which is at 8.1 which led me to this post

Theoretically The Futures Price = Spot Price + Cost of Carry.

Looks like Theory is thrown in dustbin for today :)

Will post more once my blogger is up

Pradeep Reddy Lekkala