AS Pakistan struggles to bring its’ inflation down to eight per cent in FY06, its’ Indian neighbour has managed to contain inflation in the 4-5 per cent range. Although ostensibly, India began its policy of tightening a full year before Pakistan, their monetary policy is not the only reason why Indian inflation is much lower than Pakistani inflation.

In fact, the composition of the consumer price index (CPI) and wholesale price index (WPI) basket, the food supply situation and the oil subsidy in India are the more important reasons for Indian inflation levels being lower than the Pakistani inflation levels.

The CPI basket in Pakistan assigns higher weights to the house rent, fuel and lighting group and transport group than the Indian CPI. Interestingly, the Indian CPI measure assigns a higher weight to ‘pan, supari, tobacco, and intoxicants’ than to transportation. This partially explains why rising fuel prices do not seem to have had the same impact on the Indian economy that they have had on Pakistan’s.

Since the food group constitutes the majority of India’s CPI it is also relevant to point out that in recent years Indian agricultural output has been such that food shortages have not pushed prices upwards, year on year (remember the base effect matters when measuring inflation).

However, in India it is not the CPI index but the WPI index which matters and if we compare the two (i.e. Pakistani CPI with Indian WPI) the disparities in weights are greater.

On the other hand, the WPI inflation rate in both countries is hardly similar, a fact that can be accounted for largely by looking at weights. To illustrate, Indian food inflation has risen by 6.83 per cent as of the end of February and Pakistani food inflation has seen a rise of 6.9 per cent by the end of February, which is not a significant difference.

However, because of the discrepancy in weights, the Pakistani index overplays (relative to India) the impact of food prices. India assigns a 15.4 per cent weight to food in its’ WPI whereas Pakistan assigns a 42 per cent weight to the same. Within the food group weights vary as well, as India assigns less than two per cent to wheat and wheat products and Pakistan’s WPI weights are assigned on the basis of the value of marketable surpluses.

Given that wheat prices in India are 20 per cent higher than those in Pakistan, the difference in weights assigned to wheat will undoubtedly impact the numerical value for food inflation. The Indian WPI also gives a much higher weight to manufactures and it is worth noting that in Pakistan year on year WPI inflation for the manufactures group stands at 3.05 per cent in Feb 6, which is close to India’s 2.3 per cent. Close, but not the same as India’s with its’ sustained manufacturing sector growth that has been better able to meet domestic demand. That aside, if we had the same weights as the Indian indices, then Pakistans’ inflation levels would be significantly lower.

The question still stands that when oil prices began to skyrocket, why did Pakistan’s WPI rise at an alarming rate, when its’ Indian counterparts actually fell. There are four reasons for this. One is an easing of food inflation relative to a high base, the second is the effect of monetary tightening, and the third is the fact that the Indian WPI assigns a much lower weight to fuel than the Pakistani one. The fourth, and most important, one by far is the role of subsidies in keeping India’s domestic oil prices low (refer to inset).

To give credit where credit is due, the Reserve Bank of India has been much more proactive in their inflation fighting than their counterparts on this side of the border. Recognizing the significant lag between monetary tightening and an easing of inflationary pressures they have conducted ‘pre-emptive strikes’ of sorts, raising key rates before inflation rears its’ ugly head and not after. Therefore, despite the fact that annual inflation in India is below five per cent they revised their key rate (reverse repo rate) upwards by 25bps to 5.50 per cent.

However, at the end of the day, weights also matter. If the Pak WPI or the Pak CPI were composed in the same manner as our illustrious neighbours’, then the value assigned to domestic inflation would be quite different. Does this mean that we should recompose our inflation indices along Indian lines? No, it does not. All it means is that in cross country comparisons, numbers should always be interpreted with caution.