Core inflation

Topic: Inflation and Index Numbers: CPI, WPI, IIP and the Deflator · NCERT: Class 11, Ch 7 "Index Numbers"

Meaning

Core inflation is the rate of inflation after removing the items whose prices jump up and down quickly, mainly food and fuel. In India today it is measured on the CPI excluding food and fuel.

It matters because it shows the steady, demand-driven part of price rise, which is the part that monetary policy can actually influence. The RBI uses it to tell a short supply shock apart from lasting price pressure.

Formula (year-on-year, like any index-based inflation rate): Core inflation (%) = (Core CPIₜ − Core CPIₜ₋₁₂) ÷ Core CPIₜ₋₁₂ × 100, where Core CPI is the CPI without food and fuel, and t is the current month.

Explanation

Why food and fuel are removed

• Food prices follow the monsoon.
• A poor monsoon means a smaller harvest, and vegetable and pulse prices shoot up.

• A good harvest the next year brings them down again.

• Fuel prices follow world oil markets.

• A war or an OPEC supply cut raises crude oil prices, and India's fuel prices rise too.

• India has no control over this.

• The repo rate cannot fix these shocks. The repo rate is the interest rate at which the RBI lends money to banks for a short time.

• A higher repo rate cannot make it rain or bring down world oil prices.
• So the RBI removes these items to see what is happening to demand underneath.

What drives core inflation up or down

• Strong demand pushes core up:
• People earn more, borrow more and spend more.

• Firms can raise prices of clothes, household goods, services and so on.

• Wages and expectations:

• If people expect prices to keep rising, workers ask for higher wages.

• Firms then raise prices to cover the higher wage bill, and core inflation rises further.

• Second-round effects: a food or fuel shock can leak into core over time.

• Costlier diesel → higher transport charges → higher prices of many non-food goods.

• That is why a lasting food or fuel shock still worries the RBI, even though core leaves these items out.

• Tight monetary policy pulls core down:

• Repo rate up → bank loans cost more → people and firms borrow and spend less → demand cools → core inflation eases.

Worked example: reading headline and core together

• In a given year, headline CPI inflation is 6%. After a poor monsoon, food prices rise 10%. Core inflation is 4%.
• Rough check: food has a weight of about 36.75% in the CPI 2024 series [5]. Leaving fuel aside for simplicity: 0.3675 × 10 + 0.6325 × 4 ≈ 3.7 + 2.5 ≈ 6.2%, which is close to the 6% headline rate.
• Reading it: most of the rise in headline inflation comes from food. Underlying demand is at the 4% target.

• Policy call: the RBI may not raise the repo rate. The right answer to this kind of food spike is supply-side action.

• Now suppose core inflation is also 6%.

• Price pressure is spread across the whole basket, not just food.
• Demand is too strong, so tighter policy (a higher repo rate) is justified.

In India

• Current measure: core inflation is CPI (Combined) excluding food and fuel. CPI-C (the Consumer Price Index – Combined) covers rural and urban households and is compiled by NSO, MoSPI.
• Old measure (NCERT, now outdated): NCERT uses WPI non-food manufactured products, which make up about 55% of WPI. That approach was dropped when India moved from WPI to CPI as its main inflation measure.
• How CPI became the main inflation measure:
• The Urjit Patel Committee (2014) recommended that the RBI treat CPI (combined) as the key measure of inflation [2].
• India formally adopted flexible inflation targeting (FIT) in June 2016 [3].

• On 5 August 2016, the government notified a target of 4% CPI inflation, with an upper limit of 6% and a lower limit of 2%, for 5 August 2016 – 31 March 2021 [3].

• The target is headline inflation, not core inflation: the 4% ± 2% target applies to headline CPI. The RBI tracks core inflation as a diagnostic tool, meaning it uses it to find out why headline inflation is moving.

• New CPI series (base 2024 = 100) [4]:
• Its basket and weights come from the Household Consumption Expenditure Survey (HCES) 2023-24 [4][5].
• The weight of food and beverages has fallen to 36.75%, from 45.86 in the 2012 series [5]. So the non-food part of the basket, which is where core inflation is measured, now carries more weight.
• The number of weighted items rose from 299 to 358, and the series uses the COICOP 2018 classification [5].

Don't confuse with

• Headline inflation: this is inflation on the full CPI-C basket, including food and fuel. It is the rate the RBI is legally required to target. Core inflation leaves food and fuel out and is only a tool for reading the data.
• NCERT's core inflation (WPI non-food manufactured products, about 55% of WPI): this is the old, WPI-based measure. For current questions, core inflation means CPI excluding food and fuel.
• Food inflation / WPI Food Index: this measures only food prices. The WPI Food Index = food articles + food products, with a weight of 24.23 in the 2011-12 series. Core inflation is roughly the opposite: everything except food and fuel.
• WPI inflation: this covers wholesale goods only, with no services, and is compiled by OEA-DPIIT. Core CPI includes services such as housing, health and education, which are a large part of underlying demand.

Prelims Hooks

• Core inflation = inflation excluding food and fuel. In India it is currently measured on CPI (Combined), not WPI.
• Trap: NCERT's definition (WPI non-food manufactured products, about 55% of WPI) is outdated.
• Trap: India's FIT target of 4% ± 2% (notified on 5 August 2016) applies to headline CPI inflation, not core inflation [3].
• CPI is compiled by NSO, MoSPI. WPI is compiled by the Office of the Economic Adviser, DPIIT, not by MoSPI.
• The Urjit Patel Committee (2014) made CPI (combined) the key measure of inflation [2].
• CPI 2024 series: food and beverages weight is 36.75% (earlier 45.86) [5], so food has less influence on the gap between headline and core inflation.

Mains Points

• Supply shock or demand pressure? Core inflation helps the RBI decide what kind of inflation it faces.
• If headline inflation is high but core is low, a food or fuel shock is the likely cause. The fix is supply-side action: buffer stocks, easier imports and better storage. Repo rate hikes would only hurt growth.

• If core inflation is also high, demand is broad-based and monetary tightening is justified.

• Why target headline and not core? Households spend a large share of their income on food, so their inflation expectations and wage demands follow headline prices [2][3].

• Targeting only core would ignore the inflation that hurts the poor the most.

• A lasting food or fuel shock can also spread into core through wages and transport costs, so the RBI cannot ignore it for long.

• The effect of the new CPI 2024 weights: food's weight has fallen to 36.75% [5], and core items now carry more weight in the basket.

• Headline inflation may swing less with the monsoon and move more closely with core.
• This can make the RBI's policy signals clearer and reduce how often it has to "look through" food shocks.

Related concepts

• Wholesale Price Index
• WPI major groups
• WPI Food Index
• Producer Price Index
• Headline inflation

Read more

• WPI, PPI, and headline vs core inflation