As India grapples with inflationary pressure in the wake of the Ukraine war, the moot question is how representative our current inflation gauges have been to capture the real price pressure in the economy. The consumer price index (CPI), which is used by the central bank for its inflation-targetting framework, has been in existence for a decade now without any revision. Pronab Sen, former chief statistician and the then chairman of the National Statistical Commission, says the current CPI is outdated.
In an interview with Banikinkar Pattanayak and KG Narendranath, Sen says retail inflation could have possibly come in higher than the current reading of 6% had the index been revised on time. The RBI, some would say, is behind the curve; but that’s probably because it doesn’t know what the real curve is, given the outdated index, Sen adds. He also argues, given the persistent weakness in both labour and product markets, inflation can be self-limiting to a large extent.
He says the current export boom may have been partly driven by the producers’ move to utilise vast idle capacity, mirroring the vent-for-surplus theory. Edited excerpts:
The current consumer price index (CPI) hasn’t been revamped for a decade now. Is it still a representative indicator of inflationary pressure in the economy?
Over the last ten years, there have been a lot of structural changes in the economy. As a result of that, the current consumer price index (CPI) is seriously out of date. A decision was taken to revise the CPI and the wholesale price index (WPI) every five years to better capture the structural changes. So, 2017-18 was the nearest year for a revision. But the consumer expenditure survey for that year is now junked (by the government), so we must wait for the next survey. And the earliest that can come is 2022-23. This means you are not going to get the survey data until the beginning of 2024. Only then you can start the process of revising the CPI. I don’t think we will get a revised CPI before the end of 2024 or in 2025.
Until the revision is done, what is the consequence of measuring retail inflation based on an inadequately representative CPI?
Two things are critical here. First, income distribution changes over a period of time. So, the consumption pattern of a particular class can become more or less dominant. Currently (after the pandemic), it’s more gravitated towards the high-income groups.
Second, as new products come in, the composition (of the price index) changes for every category as well. So, both have their impact on the price index but which way it will swing more can’t be predicted now. Because, in that case, you have to know the inflation of each of these products. That’s impossible to predict a priori.
If the main driver of CPI inflation is food, as it was in the past, then the question to ask is within the category, which one is driving the consumption pattern more — cereals or basic food items or horticulture products, etc. The poorer people are much more into staples and the richer people have horticulture and animal products. But if you see the inflation behaviour in recent years, it has been driven more by non-food items, which are a more diversified category.
If non-food products had appropriate weight in the index and the CPI had been more representative, keeping with the current realities, would the current retail inflation measured higher than 6%?
Yes, it could have been higher. But, as I said, it’s difficult to predict a priori, so the index revision needs to be done first.
Don’t you think services aren’t adequately represented in the CPI now?
In services, there is an issue, and that’s probably the case across the globe. In this category, it’s very difficult to define a product because they are very heterogenous. In the current CPI, health and education expenditures are captured, and a whole bunch of other services can be included. However, the problem, again, is how to define such a product. Even within goods, this is a problem, albeit to a lesser extent. That’s because when you define a very specific product, what you are essentially assuming is that all the other products in that same category will have the same price behaviour. So, if you are looking at toothpaste and Colgate as a representative product, you are assuming all other toothpastes move along with it. It may not be true in case of certain goods, and in services, it’s almost certainly not true.
What is your assessment of inflation in the light of elevated crude oil prices? The RBI’s inflation projection of just 4.5% for FY23 (made before the Ukraine war) looks like an underestimate and the central bank governor has also hinted at a revision.
As far as inflation is concerned, in a situation, when both the labour and product markets are weak, inflation may not go far. This is simply because most producers can’t pass on the cost increases. In particular, labourers may not be able to demand the kind of wage increases that they need. If that doesn’t happen, then the (inflation) process will be self-limiting. Demand situation was already weak in the wake of the pandemic.
However, if the distributional changes are such that the demand for products usually consumed by the richer sections of society is going up, then inflation may go up. But even there, there is a certain degree of self-limiting factor. At the moment, there is weakness in (private) demand at the broader population level, but at the high-end, there is no weakness.
How do you see the CPI-WPI divergence? While the WPI is in double-digit for 11 months now, the CPI, despite the recent acceleration, is still about 6%.
The WPI is measuring what is on the producers’ side. For instance, the wholesale price index has a very high weight of raw materials. The pass-through between the WPI and the CPI depends on the ability of producers to pass on the rise in input costs. That process is probably weak now because of weakness in the economy. But there are some sectors where producers are able to pass it on, but it’s not the case with all sectors. Of course, in the formal sector, companies have witnessed robust growth in their bottom lines. So, clearly, that is a segment where the passthrough of costs has been quick.
Unfortunately, many have got into the habit of using only the CPI. So, if you want to assess the real growth of credit flow, the WPI is, in fact, a better measure. So, when people say real credit growth is now positive, they are looking at the CPI. The right way to look at it is to factor in the WPI, which will show negative credit growth.
How can we make a proper inflation index for the monetary policy committee to look at? Should we adopt a judicious mix of the WPI and the CPI for inflation targetting?
Everything depends on what you see as the transmission mechanism. The logic of using the CPI is that it represents the end-product. If the CPI starts going up, you need to react. Now, this is a logic that works fairly well in developed countries for a couple of reasons. One, developed countries have a very high level of consumption borrowings by households. This is also growing in India now, but it’s still not high enough. So, in developed countries, when you raise the interest rates, you are actually increasing the cost of consumption. However, in India, when you raise the interest rates, it inflates the cost of production. So, there needs to be clarity on what we really want.
Now that the CPI revision is going to be late, what will be its impact?
Well, the fallout is you are basing policy decisions on something that is not very accurate now. So, the RBI is saying that we are still within the comfort zone and inflation is just marginally above 6%. But, if the CPI is revised, it might well be higher (of course, the reverse may also be true). But, suppose, the actual inflation is 7-7.5% and you are assuming it to be about 6%. In that case, if you are not trying to control it now, the price pressure in the economy will continue to build. As they say, you are behind the curve, simply because you don’t know what the curve is. That’s’ the problem. If you listen to the monetary policy committee, it says we have to be ahead of the curve. But if you don’t know the curve because of the outdated data, what will you do?
India’s goods exports have grown over 37% on year this fiscal to breach the ambitious target of $400 billion. Is this high pace of growth in exports sustainable?
What I don’t know is the source of exports. There is an argument which was very popular at one time but has completely gone out of our discussion now, and that is the vent-for-surplus theory. This essentially means that if a country has a high level of unutilised capacity, then producers use that idle capacity (because their fixed cost is already taken care of) to sell products at relatively low costs. This leads to greater exports. But this is something that works only so long as you have large unutilised capacities. However, as the domestic economy starts picking up and capacity utilisation begins to go up, the surplus exports may come down. I suspect, the current export boom is partly driven by this vast unutilised capacity of Indian Inc.