The Hindu Business Line : Getting the measure of inflation

Current inflation indices do not adequately cover service sector output, overlook the consumption patterns of half the working population and are based on sketchy price data.

The government’s move to construct a new consumer price index (CPI) for urban India, replacing the CPI for urban non-manual employees (UNME), has not come a moment too soon. The Reserve Bank of India Governor, Dr Y V Reddy, has rightly expressed the need for a reliable consumer price index as a guidepost to monetary policy. Consumer indices — for UNME, agricultural labour, rural labour, industrial workers — are unsatisfactory for a number of reasons. They do not adequately cover service sector output; overlook the consumption patterns of half the working population, namely the self-employed; use outdated weights; and are based on sketchy price data. Hence, the wholesale price index is taken as the key marker of inflation, even as it tracks producer rather than retail prices, that too in an imperfect manner.

A number of agencies are involved in reporting prices for the 435 items listed in the WPI, and the process is far from foolproof. Data collection is not the only problem; the weights ascribed to goods and services in the WPI and CPI should be changed periodically to reflect contemporary economic trends, with new items being added from time to time. The services sector, which represents 55 per cent of gross domestic product, is sorely under-represented. The share of services in the to-be-abolished CPI-UNME is 24 per cent, while it is 16 per cent in the case of CPI-IW and 12 per cent in the two rural indices. According to estimates, the indices cover only about 60 per cent of the goods and services in the market. They have clearly not kept pace with post-reforms trends. Competition has increased the range of goods and services on offer and brought down prices, a fact that is not captured by these indices.

Consumer indices do not factor in the declining share of food in total household expenditure and, within that, of cereals, since the 1980s. Exaggerated weights for food items lead to an overestimation of inflation at a time of rising relative food prices and vice-versa. Weights should be periodically adjusted on the basis of household expenditure surveys carried out by the National Sample Survey Organisation. The weights in the urban indices are based on ad hoc family expenditure surveys rather than NSS estimates. Further, there is a discrepancy between the prices computed from the NSS surveys, arrived at by dividing the expenditure on a good by the quantity consumed, and the retail prices that go into the indices. The National Statistical Commission should look into the quality of data used to compute prices and weights, while fine-tuning the NSS methodology as well.

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