Welfare schemes have reshaped the retail prices that matter to people

First, the background: In January 2023, the government announced a programme to supply free foodgrains (wheat and rice) to around 800 million households covered under the National Food Security Act.

This announcement followed a series of ad hoc extensions to the free distribution of essential goods initiated during the covid crisis. The relevance of this scheme to the index arises from the fact that wheat and rice account for a weight of almost 7.5% of the all-India combined CPI.

Also read: Mint Primer | All about the inflation spike: how, why & when

The discussion paper therefore highlights two challenges. One, how to account for the reduction in price of Public Distribution System (PDS) items from a positive value to zero in the ongoing series; and two, how to treat free PDS items in the proposed new series after the ongoing base-revision exercise is done.

The paper follows a ‘user consultation’ by MoSPI earlier on the same topic. This exercise raised speculation about its impact on inflation measurement, as it coincided with observations made by the chief economic advisor and others (including this author) on omitting food inflation from the ambit of monetary policy discussions.

Insofar as the treatment of free foodgrains for the future series is concerned, the paper cites the International Monetary Fund manual on CPI compilation, which recommends excluding from the index items that are provided free by the government or non-profit institutions.

This is correct because food is only one of the things provided free by the government. We do not, for example, seek to include the cost of internal or external security, which is a standard provision by governments.

As for the treatment of free distribution of PDS in the ongoing series, the paper suggests that we either redistribute the weight of these items to other items within the same class or redistribute the weight broadly over all items in the basket. The paper states that the first method was adopted (at some point) in the ongoing series. This, however, is highly problematic.

First, free distribution increases the disposable income of consumers (because of savings on those items). How this extra income is spent depends on the preference pattern of the consumer. It is certainly not the case that the extra income will be spent only in the category where free distribution occurs.

For example, it is highly unlikely that a household getting free rice will be spending the resultant increase in disposable income only on rice and/or other cereals. The correct approach would have been to re-allocate the weight of these items across the entire consumption basket.

Further, regardless of the method adopted, when the change was introduced, indices with and without the change should have been produced, alerting users to the change and its impact. This parallel production of indices should have been continued for a period of at least one year to allow users to see the directional impact of the change.

Not adhering to this basic principle of transparency increases doubts about the validity of government statistics on the whole and results in unnecessary speculation on likely reasons. In this case, concerns have been raised about the likely effect of these issues on inflation measurement and consequent policy.

Also read: RBI can expect climate risks to emerge as important policy inputs

The impact of free distribution of foodgrains on inflation is likely to be small. This is because most of the inflation in food products arises in the categories of fruits and vegetables, protein-rich items and edible oils.

As a result of a government-run procurement programme that offers minimum support prices (MSPs), cereals (particularly wheat and rice) tend to witness relatively less retail price instability. The most volatility in these categories is visible in specialized items that are not covered by the MSP system, such as Basmati rice.

Given that such items have a low share in the consumption basket of the median consumer (which is what the CPI tracks), the impact on overall inflation would in any case have been small. However, opaqueness in the adjustments adopted leads some people to doubt even correct statistics.

The issue of free distribution of foodgrains raises a larger concern when it comes to CPI compilation and household consumption patterns. The government may, for example, seek to include the distribution of pulses and edible oils under welfare schemes (demands for which are already being made). This would have an even larger impact on consumption patterns.

It is therefore important that India’s Household Consumption Expenditure Survey be made a regular ongoing exercise, as is being done with the Periodic Labour Force Survey and Annual Survey of Unincorporated Sector Enterprises.

This would allow construction of the CPI as a dynamic chain index with frequent revisions to its weighting diagram and item basket. The benefits of this would not only cover existing policies like dearness adjustment (which may even allow for savings thanks to more precise estimations) and inflation targeting, but also the country’s response to black-swan events like the covid outbreak.

To sum up, transparent methodologies, coupled with regularly conducted household consumption surveys, can mitigate doubts and improve the utility of the CPI in policymaking.

Also read: It is time India started indexing tax slabs and exemptions with inflation

As welfare programmes expand, regularly updating inflation metrics by actual consumption patterns will not only enhance statistical accuracy, but also enable better informed economic decisions. It would build trust in public data systems and support effective governance.

The author is a former chief statistician of India.