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Saturday, September 23, 2006

Cost Inflation Index grows five-fold in 25 years??

My first alma mater the Institute of Chartered Accountants of India started a good service for its members. ICAI sends out a Knowledge Capsule to all its members who opt for the service. The capsule is a summary of headlines from the leading newspapers that may be pertinent in the practice of the profession. I find it a good service. This post is not about the service per se, though.

This headline recently caught my eye - "Cost Inflation Index grows five-fold in 25 years" ?? The author is someone I respect for his good writing in Business Line. I have enjoyed his articles while I was a CA Student in the late 90s. I still do respect the quality of his writing. However, the tilt of this particular article made me wonder.

I wanted to put it in perspective. A back of the envelope calculation would show that a 5-fold increase in anything in 25 years is less than 8% per annum (the spreadsheet would show 6.81%). 8% is close to the interest rate prevailing interest rates for India during this time period.

"In the first few years, CII grew only by single digits. The latest jump is of 22 points, from 497 in 2005-06. The biggest increase thus far was in 1999-2000, when CII vaulted by 38 points to reach 389."

These lines again made me wonder. Of course, the single digit growth in the initial years is a property of any price index. Since the base is low - 100 in 1981-82, as the article points out - the year-on-year (YOY) growth would be low too. That is a 9% inflation in 1982-83 would make the 1982-83 CII to 109. However, as the index grows in value to say 497, the growth would also be magnified. The 22 point jump amounts to only a 4.4% rate compared to the 9% in 1982-83. This should be good news, really, going just by this jump!!!! The 38 point increase in 1999-2000 is a 10.8% increase, not so good news. But compared to the 1982-83 inflation, it is only a 1.8% higher rate. It also would suit the prevailing conditions in the economy - the after-effects of the IT boom and all.

My interest in bringing all these numbers up is to prove just one point - it is the relative values that matter, not absolute. I have seen the same thing happen with the reporting of Sensex values as well. A 200 point rise in a day when the index is at 11000 is only less than 2% and is equal to an 80 point rise when index was at 4000.

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