What is inflation, and how is it measured in India?

Statisticians cannot follow every price, so they follow a fixed basket: the things a typical household buys, weighted by how much of its budget each one takes. Food, housing, fuel, clothing, transport, health and education all go in. Price collectors record what the items cost in sampled markets every month, and the cost of the basket is compared with the cost of the same basket a year earlier. The percentage change is the inflation rate.

India has two main official measures. The Consumer Price Index (CPI) follows what households pay, and its all-India figure comes from the Ministry of Statistics and Programme Implementation every month. The Wholesale Price Index (WPI), published by the Office of the Economic Adviser in the Commerce Ministry, follows prices at the wholesale stage and covers goods but not services. The two often move differently, because a rise in the price of a raw material takes time to reach the shop shelf, and some of it never does.

Food and beverages have historically made up close to half of the Indian CPI basket, far more than in rich countries, so the price of vegetables, pulses and cereals can swing the headline number. A poor monsoon, or a spike in the price of onions or tomatoes, can lift inflation for a few months even when the rest of the economy is calm.

That is why analysts also quote core inflation, which leaves out food and fuel, to see the underlying trend. If headline inflation is high only because of vegetables and core is steady, the pressure is likely to fade with the next harvest. If core is rising too, price pressure is more widespread.

Since 2016 India has run a flexible inflation-targeting framework. The government sets the target, and the Reserve Bank of India's six-member Monetary Policy Committee decides the policy interest rate with that target in mind. The target has been 4 per cent, with a tolerance band of 2 to 6 per cent. If inflation stays outside the band for three consecutive quarters, the RBI must report to the government on why, and on what it will do.

Raising the policy rate makes borrowing dearer, which cools spending and, over time, price pressure. Lowering it does the opposite. The rate also has to be weighed against growth, so the committee is balancing two aims at once. Our guide to the repo rate explains how a decision travels to loans and deposits.

The useful way to think about inflation is as a tax on idle money. What matters for a saver is the real return: roughly the interest earned minus the rate of inflation.

• Savers: a deposit earning 6.5 per cent while inflation is 5 per cent grows your purchasing power by only about 1.5 per cent a year. If inflation is higher than the interest, the money buys less each year even though the balance grows.
• Borrowers: a fixed-rate loan becomes easier to repay in real terms when prices and wages rise, because the instalment stays the same while incomes grow. Lenders lose in that case, which is why they charge more when they expect higher inflation.
• Wage earners: a pay rise that is smaller than inflation is a cut in real pay.
• People on fixed incomes, such as many pensioners, feel inflation most, which is why some pensions and allowances are linked to price indices.

When a headline says inflation rose to 5.5 per cent, that figure is almost always the year-on-year change: prices this month compared with the same month last year, not with last month. A fall in the inflation rate does not mean prices fell; it means they are rising more slowly. Prices that actually fall across the economy are called deflation, which is rare and brings problems of its own.

Check which measure is being quoted (CPI or WPI, headline or core, all-India or rural or urban), and remember that the figure is an average. Your own inflation depends on what you buy: a household that spends most of its budget on food and rent feels a different rate from one that spends mainly on travel and electronics.

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