The CPI basket: problem of relevance and true measurement of inflation

The CPI basket: problem of relevance and true measurement of inflation

Subject :Economy

Section: Inflation

In Brief: India’s consumer price index (CPI) basket of goods continues to include items that are no longer relevant to a normal consumer (eg. Radio, DVD player). The consumption basket changes because of both technological changes, but also because of economic growth.

Key Points:

• To correctly measure inflation, the CPI basket composition should correctly reflect the actual consumption of an average person. This is important as wage revision, monetary policy are all dependent on the actual inflation experienced.
• There are majorly two factors that necessitate revision of consumption basket in terms of composition:
  • Development: With development, the proportion of income spent on food reduces and the budget for other goods such as leisure, education increases.  The real consumption basket is fluid and continually evolving, reflecting the shifts in societal needs, preferences, and economic conditions. As time progresses, consumption patterns of individuals and households inevitably change.
  • Technology: With change in technology and economic development many items become obsolete, such as radio, cassette player, etc. Although these have a minimal weight in the overall CPI calculation, we are clinging onto the past, tracking items that no longer hold the same relevance in our consumption patterns.
• Importance of changing weights: Apart from the composition of the basket, the weights given to each item too are flawed.
  • In the current CPI (base year 2012), weights of various groups are as follows: food and beverages (45.86); paan, tobacco and intoxicants (2.38); clothing and footwear (6.53); housing (10.07); fuel and light (6.84); miscellaneous (28.32).
  • The weightage of food in the CPI basket has decreased from 60.9 (in 1960) to 57.0 (in 1982) and to 46.2 (in 2001).
  • This gradual decline indicates that as the economy grows, the proportion of income spent on food decreases. This is a common trend known as Engel’s Law, which suggests that as income rises, the proportion of income spent on food falls, even if the absolute expenditure on food rises.
  • As people’s income rises, they tend to allocate a larger proportion of their spending towards non-food items such as housing, education, healthcare, personal care, entertainment, and digital services such as the Internet. This reflects a general improvement in living standards and a broadening of consumer demands.
  • Over-reliance on food inflation today distinguishes Indian inflation from many other developed countries where the food weight is much smaller.
• Change within food basket:
  • The high weight of 9.67 assigned to cereals in the current CPI brings focus on two critical issues.
    • With economic advancement and societal progress, there is a diversification of the food intake and expenditure on nutrient-rich options other than cereals increases. This change in relative expenditure on food items other than cereals is not reflected in a revision of sub-weights or the item list within the food basket.
    • Additionally the government food support in form of Pradhan Mantri Garib Kalyan Yojana has substantially reduced cereal expenditure for a large segment of the populace. It also hints towards a change in the consumption pattern and a reduction in the relative expenditure on cereals.

Household consumer expenditure survey (HCES) and CPI basket design 

• Household consumer expenditure survey (HCES) is the primary source of statistical indicators on social consumption and wellbeing, living and inequality thereof and for estimating various other parameters.
• Information collected in the Household Consumption Expenditure Survey will be primarily used for preparation of weighting diagram, through determination of budget shares of different commodity groups in total consumption. The data availed is further analyzed for the designing and compilation of consumer price indices for rural and urban India.

Significance of Consumption expenditure measurement

• It is difficult to have updated weights for a revised inflation basket, without access to up-to-date consumption expenditure data.
• Currently, the Ministry of Statistics and Programme Implementation (MoSPI) is in the midst of the Consumption Expenditure Survey (CES), with the first round slated to conclude in July 2023 and the second round a year later, in July 2024.
•      The absence of CES also results in inability to determine the population under the poverty line accurately, and our ability to track inflation effectively has been severely undermined. Our tools for understanding and managing our economic reality are grossly inadequate.