How far is monetary policy guided by misread inflation? CPI basket ‘outdated’, revision unlikely before 2025

Despite the index limitations, CPI inflation breached the upper band of the RBI’s 2-6% target for a second straight month in February.

Firmed up a decade ago, with 2012 as the base year, the CPI, used by the RBI for inflation-targeting, is crying for a revision. (File)
Firmed up a decade ago, with 2012 as the base year, the CPI, used by the RBI for inflation-targeting, is crying for a revision. (File)

When was the last time you hopped on to a horse cart? Or bought video cassettes to watch movies, enjoyed a boat ride, used dung cakes to cook? If the answer eludes you, then the retail inflation gauge, comprising 299 items, including scores of such “outdated” goods and services with inflated weight, is no longer a true barometer of price pressure in the economy.

Firmed up a decade ago, with 2012 as the base year, the CPI, used by the RBI for inflation-targeting, is crying for a revision.

At a time when a spurt in inflation across the globe, particularly in the wake of the Russia-Ukraine conflict, is forcing key central banks to act, a faulty price index is the last thing the Reserve Bank of India (RBI) would like to have while firming up its own action plans.

The monetary policy committee next meets on April 6-8 to review key policy rates and inflation forecasts. Despite the index limitations, CPI inflation breached the upper band of the RBI’s 2-6% target for a second straight month in February. It’s set to exceed the mark again in March, aided by the latest hikes in fuel prices.

RBI governor Shaktikanta Das recently said the 6%-plus retail inflation was transitory but added that the central bank’s 4.5% forecast for FY23 would be “reworked”.

“There is no doubt that the current CPI (consumer price index) basket is outdated,” Pronab Sen, former chief statistician who also headed the National Statistical Commission (NSC) when the CPI was last revised, told FE.

Over a tenth of the goods and services in the extant CPI need to be junked. The weight of many more items must be revised and the product basket widened substantially to capture the changing consumption pattern of India today, a senior government official conceded.

“For instance, there is a need to raise the weight of healthcare services in the CPI (from 5.89% now), especially after the pandemic,” said the official. Similarly, the weight of cooked meals may have to be revised up from 2.62% now, thanks to the likes of Zomato and Swiggy that have made home delivery of food very convenient, he added.

Yet, an expeditious revision of the CPI isn’t in sight. A new consumption expenditure survey (based on which the CPI product basket is designed, and weight is assigned to items) can’t be undertaken before 2022-23. The survey is typically conducted from July through June. This means a new index is unlikely to be a reality before 2025. “Without this survey, we can only surmise what needs to be the composition of the index but we can’t make it,” said the official quoted above.

The RBI has recently been critiqued by some quarters for being ‘behind the curve’ by sticking to its growth-supporting accommodative policy stance. If a timely revision of the inflation index showed higher price pressures in the economy, such criticism could have gained more legitimacy.

Noted economist Sudipto Mundle, who chaired the technical committee that submitted a report to the NSC on the back-series GDP data, stressed that the CPI needs to be revised fast. If the government wants, it can re-consider the findings of the 2017-18 consumer expenditure survey to carry out a swift revision of the index; it may come up with another survey later to revise again, he added.

NR Bhanumurthy, vice-chancellor of Dr BR Ambedkar School of Economics University in Bengaluru who headed a sub-group formed by the Mundle panel on linking the old and new GDP series, too, suggested CPI revisions in regular intervals to better capture current realities. The product basket should also be as broad as possible to reflect real inflationary pressure, he argued.

The problem is the government has already junked the 2017-18 consumption expenditure survey on the ground of data quality issues and incorrect methodology. (Critics have accused it of “suppressing the adverse findings” in the report). This dashed the hopes of a proposed revision of the CPI base year to 2018 from 2012 (the inflation rates using the 2012 base year were announced from January 2015). Moreover, having disputed the survey’s methodology, it would be hard for the statistical body to possibly use its findings to re-base the CPI. To be sure, the government wanted to conduct the consumption expenditure survey in 2020-2021 and 2021-22, incorporating all the data-related refinements. But the sudden outbreak of the pandemic in early 2020 and the consequent income losses severely distorted the consumption pattern of most Indians, forcing the government to abandon the idea.

WPI, too, has outdated product basket

Not that the other key important price gauge is much better. The current wholesale price index (WPI) series, announced in May 2017, has 2011-12 as the base year. This makes the product basket dated.

However, the silver lining is that the industry ministry has announced that it will change the WPI base year to 2017-18. It’s also working on revamping the index, and the process should be over in FY23. The revision of the WPI is also not as complicated an exercise as that of the CPI, according to Sen.

Since the WPI is used in the deflator to estimate real growth in gross domestic product and gross value added, an updated WPI is crucial to the computation of real growth of national income as well.

The history of revisions

The CPI has so far been tweaked once (with 2012 base year) after its debut in 2010 (the first monthly CPI inflation rate was announced in January 2011). Earlier, the government used to measure retail inflation for only certain segments of population (such as industrial workers and agricultural and rural labourers).

Much before the CPI came into existence, the WPI, however, was the primary gauge to assess inflationary pressure. It has gone for six revisions so far since its introduction in 1952-53.

Likely changes in next revisions

While the CPI revision hinges on the consumption expenditure survey, government officials and analysts say any such survey will invariably point at the need to junk a good number of items and add scores of new ones to the product basket. Even the sample size, weight allocation and the choice of brands for price quotations will have to be tweaked. For instance, Nokia phone prices will no longer be used for assessing retail inflation in the cell phone segment, as the Finnish firm currently accounts for less than 2% of such sales in India. Similarly, the government could substantially widen the CPI product base from 299 now to accommodate more new-age technological products. Services like horse cart ride will be removed, while the weight of products like VCD/DVD hire, video cassettes will be pruned further.

Importantly, since the consumption pattern is gradually shifting towards more protein-based items, the composition of the food index will reflect this reality. Similarly, non-food products such as clothing and footwear will likely get greater weight. Currently, food and beverages dominate the CPI with a 45.86% weight. Education and health services, too, will have a larger weight in the updated index.

The WPI, too, is expected to be revised along these lines, said the analysts. The product basket may be expanded to accommodate 750 items or more from the current 697. About 150 items or so may be dropped from the current WPI basket and new ones will be added. The number of price quotations may be raised to 9,500 or above from 8331 now to make the new series more representative of the inflationary pressure at the wholesale level.

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First published on: 29-03-2022 at 06:10 IST