Every month, every fund manager, advisor or a market savvy investor waits for numbers such as CPI, WPI, PMI etc. released by the government. Also, they closely follow RBI Governor’s monetary policy and Finance Minister’s fiscal policy. So why are these numbers watched so keenly by market participants? Here's a brief introduction about these financial indicators to help you understand why they are so important.

The Gross Domestic Product or GDP as we call it gives a picture of the financial health of the economy. It represents the total value of all goods and services produced over a specific period.

For example, if year to year GDP is up by 4%, this means that economy has grown by 4% over last year.

Measuring GDP is quite a complicated task and there are two ways to calculate it:  1) Income Approach and 2) Expenditure Approach

• Income Approach (by adding what everyone has earned)

It is expressed as follows: Total National Income + Sales Taxes + Depreciation + Net Foreign Factor Income. Total national income is equal to the sum of all wages plus rents plus interest and profits.

Income approach assumes that there are four major factors of production in an economy and that all revenues must go to one of these four sources. Therefore, by adding all sources of income together, a quick estimate can be made of the total productive value of economic activity over a period of time. Adjustments must then be made for taxes, depreciation and foreign factor payments.

• Expenditure Approach ( by adding what everyone has spent)

GDP = C + G + I + NX

C= Consumption

G= Government spending

I= Investment

NX= Net of imports and exports

Nominal GDP: It is GDP which has not been adjusted for inflation.

Real GDP: The real gross domestic product (GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced in a given year, expressed in base-year prices. Real GDP helps us know the real growth of an economy. For example, if ROI is 10% and inflation is 3%, then the real return is 6.8% and not 10% as assumed.

Inflation: Inflation is the rate at which the general level of prices for goods and services rise. A rise in inflation reduces the purchasing power of money.

Central banks normally use interest rate to control inflation. When the inflation is falling, interest rate is lowered to increase money supply, thereby enabling people to buy more. This creates more demand for goods and services and helps the economy grow.

On the other hand, when inflation is high, central banks increase the interest rate to contract the money supply and encourage saving. While India is battling to fight inflation foreign countries like Japan is facing deflation, which means declining prices.

This is generally caused due to reduction in money supply, low government spending, low demand of goods and services, etc. In such situation, the inflation falls becomes negative and people stop buying things with the expectation that in near future they will get the same thing for a lesser price. For instance, Japan has been facing deflation since 1990.

Stagflation is another phenomenon that many countries go through. In stagflation, there is rise in price coupled with low growth and high unemployment rate. 

Tools to track Inflation:

CPI (Consumer Price Index): It is a measure that examines the weighted average price of basket of goods and services. CPI is calculated by taking the price change for each item in the basket comparing to their relative price in the base year. Each good is weighed according to its importance. Changes in CPI are used to assess the price change associated with cost of living.

Good and Services included in CPI:

The CPI represents all goods and services purchased for consumption by us which fall into more than 200 categories and arranged into eight major groups. Major groups and examples of categories in each are as follows:

• Food & Beverages (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)

• Housing (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)

• Apparel (men's shirts and sweaters, women's dresses, jewelry)

• Transportation (new vehicles, airline fares, gasoline, motor vehicle insurance)

• Medical Care (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services)

• Recreation (televisions, toys, pets and pet products, sports equipment, admissions);

• Education & Communication (college tuition, postage, telephone services, computer software and accessories);

• Other goods and services (tobacco and smoking products, haircuts and other personal services, funeral expenses).

Also, included within these major groups are various government-charged user fees such as water and sewerage charges, auto registration fees and vehicle tolls. In addition, the CPI includes taxes (such as sales and excise taxes) that are directly associated with the prices of specific goods and services. However, the CPI excludes taxes (such as income and Social Security taxes) not directly associated with the purchase of consumer goods and services.

The CPI does not include investment items such as stocks, bonds, real estate, and life insurance. (These items relate to savings and not to day-to-day consumption expenses.)  

Core CPI: It measures the price increase excluding certain items that face volatile price movements. In core CPI you eliminate products which give temporary price shocks because they can give a false sense of trend of overall inflation.

Normally, energy and food items are eliminated to calculate core CPI as these sectors are very price sensitive.

WPI: WPI index reflects average price changes of goods that are bought and sold in the wholesale market. WPI in India is published by the Office of Economic Adviser, Ministry of Commerce and Industry.

Both WPI and CPI measure inflation. This data is released every month on a Thursday. This data affects the both the markets and economy.

IIP (Index for Industrial Production): IIP index shows the growth of various sectors in the economy such as: mining, electricity, manufacturing, etc. over a period of time. The current base year is 2004-05.

IIP is a composite indicator that measures the growth rate of industry groups classified under:

1. Broad sectors, namely, mining, manufacturing and electricity

2. Use-based sectors, namely basic goods, capital goods and intermediate goods.

Though many of the sectors contribute a very small portion to the economy they are highly sensitive to interest rates and consumer demand. 

PMI (Purchasing Managers Index): Indicates the economic health of the manufacturing sector. It is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment level.

PMI of 50 indicates balanced sentiment of growth. A figure above 50 represents growth in manufacturing and vice-versa. Many economists view PMI as an important indicator for the economy as a whole and not just the manufacturing sector. This is because manufacturing sector predicts recession or expansion.

We hope this tutorial helped you. For any further clarification or help don’t hesitate to drop a message.