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Economy

Consumer Price Inflation (CPI) – A Flawed Index? (For Now)

Recently I’ve been hearing a lot about how the Consumer Price Inflation (CPI) is still very high, even though the Wholesale Price Index (WPI) has been falling dramatically. WPI is at 0.44% but the latest (Mar 20) release of January data shows CPI is at 10.4%!

Something is black in the mulligatawny. A little investigation revealed a number of interesting details, most of which indicate that the CPI numbers cannot be trusted.

The Ministry of Statistics and Programme Implementation, or MOSPI, used to collect CPI data. But the National Statistics Commission decided in Feb 2008 that the base year (1984-85) was too far back, and therefore decided to change track and deploy all the field investigators to work towards a new index, called CPI (Urban). But that won’t get ready anytime soon.

So in the interim, there is no fresh data collection. How, then, do we get CPI?

There’s another agency doing inflation calculations, called the Labour Bureau. They produce CPI figures for Industrial Workers – CPI (IW) – and also other figures for agricultural and rural labourers.

MOSPI, in it’s infinite wisdom, decided to use the CPI (IW) to determine the CPI figure until the CPI (Urban) index was up and running.

Since the two indices are based on different concepts, MOSPI decided that

a)The CPI(IW) will be “factored” by a certain multiplier, and thus CPI itself would be calculated.
b) CPI is just a weighted sum of sub-level indices (Food, clothing etc.) so,
c) Each CPI “sub-level” index will now be a factor of the main CPI(IW) index value, and the CPI would be calculated by doing a weighted sum of these sub-level indices.

Inflation sub-levels may be confusing – but here’s the story. MOSPI releases index numbers for Food, Fuel, Housing, Clothing and “Miscellaneous” separately, and a General Index based on weighting the above. We look at the general index, called the CPI, and compare it to last year, but each individual sub-level usually tells us where we’re going up.

But this no longer applies. Each sub-level will now be derived from the CPI (IW) index value, giving no real meaning to the sub-levels anymore.

Technical note: For the 24 months of Jan 2006 to Dec 2007, the factor between the CPI (IW) and the MOSPI released sub-level numbers have been collated, and an average for each sub-level is taken. This average will be used as a multiplying factor – i.e. the CPI you will see from MOSPI for each sub-level = the factor for that sub-level X CPI(IW) as released.

So for all practical purposes, the CPI sub-level data can be ignored, till the new CPI (Urban) index comes into place.

Now, let’s check the usefulness of the CPI(IW) index itself. If you look closely, it is seriously flawed as a general index indicator. It seems to be hugely biased towards food. Most of the items they reveal as part of their “selective” data is food directly – rice, wheat, dals etc. The only “fuel” items there are Kerosene, cooking coke and (hold your breath) firewood! And there’s two mentions of non-edible materials – washing and toilet soap.

This results in an index – the CPI (IW) – biased towards food, but the CPI (I mean the real thing) is only supposed to be 47% food. Of the rest (fuels, clothing etc), there is no mention of anything in the CPI(IW). No mention of Petrol, LPG or diesel, which should impact everyone much more. The CPI(IW) thus measured is barely a real indicator of urban inflation – it will flip wildly as harvest seasons vary.

With the new “factored-sub-level” formula, the results are unreliable as well. The March 20 release of CPI showed Fuel inflation at 8% compared to last year. Since last Jan we have had small fuel price hikes but much bigger drops – retails prices are at 2006 levels. Fuel inflation should therefore be negative – yet, the CPI shows 8% up, which is dramatically flawed.

Similar arguments apply for the clothing, housing and Miscellaneous subitems. As I’ve mentioned the sub-level data is unreliable. These items, added up, make up for 53% of the CPI!

Finally, the data is off by a large date as well. CPI (IW) is released on the last date of the month – for Feb, it will be released on March 30. After that, there is another 20 day gap after which CPI is reported. Which makes no sense because if it is based on a direct factor multiple of the CPI(IW), we needn’t wait! That is only a minor issue.

Overall, I think the WPI is a better indicator of inflation; at least I can see sub-item pricing and I know relevant data is being collected everytime. Plus, the WPI is more “urban” – meaning, food is a smaller constituent. CPI, for all the above reasons, and until the new index is released, is worthless. I would take any political assumption of higher prices based on the CPI with a pinch of salt.

  • Manish says:

    >Yeah, inflation is a bit of conundrum in India. With WPI also though soon it will turn negative but that is only due to base effect as we are no where near deflation with prices of various consumer goods going up!

    MOSPI is thinking of coming up with monthly data instead of weekly updates and change themethdology to month-on-month rathe than year-on-year, but it’s not clear as to how much that helps.

  • Anonymous says:

    >I don't agree with the WPI being a reliable index.I think this has more bias towards the items like fuel, crude oil, manufacturing etc.When we consider the food & vegetable prices we can't see deflation there. Prices of rice, sugar, FMCG's have gone up considerably from last year. And here we are talking about inflation of 0.44%!

  • Kenny says:

    >hi Anonymoust. i have the same idea with you about WPI. even anything happen, we still need food. therefore, the price maybe not change much.

  • Deepak Shenoy says:

    >Let me ask you: How much does food – not eating out, but food as in potatoes and onions and all that – account for, in your expenditure, as a percentage of net income?

    If you’re reading this you probably make more than 50K a month, and post taxes, end up with some 40K. You probably spend around 6k on buying veggies, fruits and milk, for a family of two/three.

    That’s 15% of income. You spend more than that on your rent/housing loan EMI. And on fuel costs (LPG + Petrol/Diesel). And some of you, on clothing and children’s school fees. For most of us, food inflation is nothing.

    For the Urban consumers, which is supposed to be reflected by CPI Urban, fuel and housing should have a higher weightage – 47% food is just zany.

    WPI has a slightly smaller weight for food and does take rents and clothing into account. Market drops have ensured the rent and clothing cost has come down dramatically (cloth cost comes down when crude falls, as polyester prices fall too)

    My monthly spend has come DOWN from last year, on the bare necessities. At the higher end, even my cell phone bills are down.