ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Construction of a Composite Leading Indicator for Tracking Inflation in India

This paper attempts to construct a 'composite leading indicator' for tracking the future path of inflation rate in India. For doing so, partial information about future inflation rate provided by a number of basic series is analysed first. Based on the correlation analysis, a few of these basic series are chosen for construction of composite indicator. Empirical results show that the percentage change in manufacturing output, money stock, exchange rate, bank credit to commercial sector, raw materials prices, are important leading indicators for inflation rate in India. Accordingly, based on monthly data on these basic series, one composite indicator is constructed which contains information about behaviour of inflation rate six months in advance. It is seen that out-of-sample forecast error of the composite indicator is quite impressive, the magnitude of error in six-months ahead forecast is only 1.2 percentage point.

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