Know-brainer : No-brainer – Series Part 3

This Guru-Shishya series started here.

1) Guruji, welcome back after a long time. I trust your vacation went very well. I had a few fundamental questions regarding inflation while you were out on vacation. You had mentioned in this post that inflation would go down to zero – and miraculously it did. And yet the prices of rice, pulses and wheat have gone up. Weren’t rice, wheat and pulses part of this inflation calculation Guruji? Is the Govt. trying to mislead people by quoting low inflation numbers, thereby indicating reduced prices and trying to rig the election?

ANSWER: Shishya, that is a very good question. Inflation (which is close to 0% nowadays), that is quoted,  is based on an index called the Wholesale Price Index (WPI). In India, under WPI, food items (rice, dal, vegetables etc) account for only about 15% of the total weightage of the index. The other part (which is the majority) of the index is consumed by fuel, crude oil, manufacturing etc. However, if you base inflation on another index called Consumer Price Index (CPI), the inflation would be around 10% and not close to 0%.  The reason for this  is while CPI gives 47% weightage to food items (rice, dal, vegetables), WPI gives only 15%. However, WPI is a better indicator of inflation than CPI.

2) But why Guruji, if the prices of food items are increasing, and the common man is feeling the pinch, isn’t it right to base our inflation on CPI rather than WPI? Why indeed is WPI better than CPI?

ANSWER: WPI and CPI are equally important and each serves a purpose of its own. However, WPI is a better indicator of inflation. Let’s take an example. Let’s say, X’s income is around Rs. 10,000. What do you think would be the amount he would spend on food items? Compare this vis-à-vis other major expenditures like fuel (for the vehicle), fuel (LPG), rental/EMI expenditure, clothing etc. Food would not cost X more than 10-15% of his income but other items (fuel, clothing etc.) will cost a lot more. WPI reflects exactly this detail (as you would observe around you, rental prices have reduced, fuel prices have come down, large discounts on clothing items are being offered etc) while CPI allocates more of its weightage to food items and hence is hardly the right indicator to the actual inflation. The actual inflation should always be based out of WPI.

3) Thank you for that enlightening conversation Guruji. Last question for the day Guruji. I have read that most of the US banks declared much better numbers than expected in Q1, 2009 (including Wells Fargo, Citibank etc). Have they finally got their act to-gether? Is this the end of recession as we see it? Or is media creating a much ado about nothing?

ANSWER: Shishya, media is bound to create much ado about nothing. That’s their job. I would actually quote from one of the best blogs in finance I have come across recently to answer your question succinctly and I quote -

“AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.”

Remember how AIG was ‘saved’ and the US taxpayers pumped in huge amounts of money (insanely, $175 billion) into AIG alone. Now, you exactly know where this money went and how come these banks suddenly declared better results than expected. Fraud, scam, cheating – it’s all very ugly out there and someone is making truckloads of money. Well, that’s how the world is Shishya.

The stupendous blog on finance is Zero Hedge. Sometimes, extremely technical, but most of the time brilliant. Spend some time on it Shishya, and you would gain a lot more wisdom than listening to those quacks on CNBC all the time. As Jim Cramer would say, ‘They know nothing, they know nothing’.

That is it for this week Shishya. I will see you some time later once you have more questions up your sleeve. Be well.

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