The statistics ministry takes on a tricky question: Should it adjust its retail inflation gauge for free handouts?
India’s inflation gauge is set for an overhaul with the statistics ministry reworking its Consumer Price Index (CPI). Should this revision take the free public distribution of food staples into account? The answer will impact the data that feeds policymaking.
India’s ministry of statistics has released a discussion paper on how items given away free by the public distribution system (PDS) should be treated by the Consumer Price Index (CPI). This is a laudable effort to reach out to all stakeholders in a bid to improve the country’s tracker of retail inflation.
The ministry’s objective is to “update item weights, revise the consumption basket and incorporate methodological improvements" to make the CPI compiled by it “more robust, resilient and effective."
The importance of this exercise cannot be over-emphasized. Inflation data drawn from this index is a key economic indicator with multiple applications.
One, the central bank uses CPI-based inflation as its principal gauge for monetary policy decisions. Two, the government uses CPI data as an input for policy interventions aimed at social welfare.
Three, CPI numbers go into the deflator used by our national accounts to adjust nominal GDP for inflation in order to estimate the economy’s real growth. And four, the CPI comes in handy for the indexation by which wages are revised, tax brackets are updated and social security payments are adjusted.
The paper deals with the tricky subject of how best to reflect the impact of items that are either given free or at subsidized rates under the PDS in compiling the CPI. Under the National Food Security Act, PDS handouts are a must and the Centre’s Pradhan Mantri Garib Kalyan Anna Yojana, which offers free foodgrains to eligible households, covers about 75% of our rural folks and 50% of the urban population.
A critical element of CPI compilation, apart from its choice of base year (presently 2011-12), is the ‘weight’ assigned to each item in its consumption basket derived from India’s Household Consumer Expenditure Survey (HCES), whose 2011-12 data remains in use for today’s series.
The problem, in a nutshell, is what’s best done in a situation where the price of a PDS item falls to zero—or conversely, goes from zero to a positive value—during the life of an ongoing CPI series. Also, whether items that are entirely free should be included in the CPI basket at all, given that households incur no direct expense on them.
The paper proposes, rightly, that considering the scale of PDS operations and their impact on consumption patterns, and taking into account the CPI’s purpose, free PDS items should be appropriately accounted for within the CPI framework.
This seems in line with the IMF manual on the subject: “If the main reason for compiling a CPI is the measurement of inflation or as an input [for] monetary policy decisions, the scope of the index should be restricted to monetary transactions only, especially since non-monetary transactions do not generate any demand for money."
The CPI is in the process of being updated with a new base year, with its weights and basket to be rejigged in accordance with data from HCES 2023-24, the latest. So it’s best not to tinker with the existing series.
For the new series, we should follow global best practices for free items and restrict the CPI’s scope to monetary transactions. As incomes rise, people’s expenses on food—and within that of foodgrains—are sure to fall anyway as a proportion of household expenditure.
The CPI weight assigned to food items, at 46% currently, will diminish as we go along. This will reduce the extent to which handouts can distort price readings, as would shrunk coverage—should any government find the political will for it. For now, let’s aim for a price tracker that captures reality as it best can.
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