Is the inflation rate in India representative of reality? Check reasons why it fails to capture real impact on masses

The inflation rate measured by the Consumer Price Index (CPI) spiked again in January’23 after being under a tolerance level of 6 per cent for two consecutive months. Inflation has been a major concern for all central banks across the globe. Like other central banks of the countries, the Reserve Bank of India (RBI) has also been taking several measures throughout the past one year to ensure inflation is under control. But do the inflation numbers in India capture the real picture? Was there actually any sign of relief when the number went down in November’ 22?

 

Why may inflation data in India fail to capture the holistic perspective?  

 

CPI measures the change in the price level of goods consumed by individuals in their day-to-day life. Individuals are the consumers who are on the demand side of the economy. For the same reason, it can be interpreted that CPI measures the purchasing power of an economy’s currency. 

CPI is calculated for a fixed basket of goods and services. For example, when inflation rate is calculated in India, it mostly takes into account food, clothing, housing, fuels, medical care and miscellaneous items.

As CPI measures the average change in prices over time that consumers pay for a basket of goods and services, the change in prices should be with respect to a particular year, which is the base year. So when we talk about the CPI basket, two major parameters to be considered are the base year and the goods/services included.

United Nations Economic Commission for Europe (UNECE) mentioned in one of their research papers, “The accuracy of the CPI depends upon representative samples for measuring price movements and that the methods and procedures for estimating and aggregating price changes in the CPI reflect the best available techniques.”

The major loophole that economists have often pointed out in terms of India’s CPI data is that the base year is 2012. UNECE stated in their paper that some NSOs, particularly in lower capacity countries, undertake weight updates infrequently, and, in a few cases, every 10 years or so. Such a long interval between updates raises serious concerns about the relevance of the CPI.

As pointed out various economists and also stated by Paul A. Armknecht, IMF Price Statistics Expert, in one of his papers that the speed with which the structure of consumer expenditures shift will vary over different time periods. During periods of rapid price change, the types and amounts of expenditure often change quickly. In such cases, the basket of items and their relative importance will shift quickly as well. It becomes important for the CPI to be able to capture these shifts in order for it to maintain its relevancy.  

 

Frequency of changing CPI inflation basket in other economies 

 

Some of the major economies like Japan, USA, UK, and Canada revises their CPI basket in every two year or at times yearly. On the contrary, India revised its CPI basket in 2012.

Although, several economists suggest that advanced economies will always have frequent revisions of the CPI basket as compared to developing economy, so it may not be just all the time to compare a developing economy with an advanced economy. On the contrary, many economists argued that India being one of the largest economies in terms of GDP, it is high time, they also tend to revise their basket more frequently. 

 

Discrepancy in weight-age   

 

One of the major loopholes in the inflation data pointed out by economists is the discrepancy in the distribution of weight-age of items in the CPI basket. Last spike in the inflation rate is driven by food inflation.

'Food and beverages' along with 'fuel and light' together constituted close to 60 per cent of CPI inflation in India. On the contrary, in many advanced economies, food weights are much lower, for instance, UK (9.3 per cent), US (13.2 per cent), Canada (15.94 per cent) and Germany (8.5 per cent), noted a report by Indian Council for Research on International Economic Relations.

A less developed country will have a higher weight of food in the CPI basket as poor people spend a higher proportion of their income on food, highlighted economists. As a country grows economically, the consumption moves more towards protein-rich and millet foods from carbohydrate-rich food.

Economists also pointed out that the impact of technological change is not captured properly while calculating the inflation rate. In sectors related to technology such as fintech and even communications, inflation has not been captured.