Decoding the Inflation number

The June 2024 Monetary Policy Committee (MPC) meeting headed by the RBI Governor has kept the benchmark repo rate unchanged at 6.5% for the eighth consecutive time. The Governor’s statement also stated that “Monetary policy must continue to remain disinflationary and be resolute in its commitment to aligning inflation to the target of 4.0 percent on a durable basis. Sustained price stability would set strong foundations for a period of high growth”. The CPI inflation for 2024-25 is projected at 4.5% with Q1 at 4.9%; Q2 at 3.8%; Q3 at 4.6%; and Q4 at 4.5%.?

RBI formally adopted the Flexible Inflation Targeting (FIT) framework in June 2016. The Consumer Price Index (CPI) Inflation – combined became the anchor for the monetary policy. In numerical terms, the target was set at 4% for headline inflation with a tolerance band of +/- 2% around it. Since then tracking inflation numbers has become all the more important. Inflation means the rate of price rise which is indicated by the Consumer Price Index (CPI). It is released by the National Statistical Office (NSO) every month. The May 2024 print came at 4.75% (y-o-y). It is the ninth consecutive month since September 2023 that the inflation number is within the RBI's target range of 2%-6% (refer below chart).

The base year considered for calculating CPI is 2012. Even when the inflation numbers may moderate in the coming months owing to a good monsoon expectation which will bring down food prices, the broader point is that RBI’s policy decision revolves around a number that has been in existence for over a decade now without any revision. The consumption pattern and the standard of living of an average Indian have changed a lot during this period. As per the Household Consumption Expenditure Survey (HCES) 2022-23 released by the National Sample Survey Office (NSSO) in Feb 2024, the Monthly Per Capita Consumption Expenditure (MPCE) more than doubled from 2011-12 to 2022-23 (refer below table)

The above table highlights the share of food and non-food items within MPCE. The weight of food and beverages in the CPI- Rural basket is 54.18% whereas the weight of food in rural MPCE is 46%. There is a difference of almost 8 percentage points if we compare the current consumption pattern with the weight assigned to similar items in the basket a decade ago. This difference can be explained by Engel’s Law. It states that the percentage of income allocated for food purchases decreases as household income increases, while the percentage spent on other non-food items such as education etc. increases. This is because the amount that can be spent on food is limited and hence, the spending on non-food items increases. This is not just applicable to the rural population but also to the urban population (refer below graph). We can see a declining trend in the percentage share of food in average MPCE based on the past three surveys including the latest one.

In the case of urban households, the share of food in MPCE is 39% whereas in CPI –Urban basket, food, and beverages weigh 36.29%. But on a combined basis food and beverages have a weight of 45.86% in the CPI basket which is more than the percentage share when we consider the average of rural and urban MPCE. Also, if we deep dive into some of the items listed under the food and beverages category we will find a significant variation in the current consumption and the weight assigned in the CPI basket. The share of cereals in total MPCE has drastically declined whereas there is an increase in the share of milk products and fruits when compared with CPI weights assigned (refer to below table).

Even if we analyze the remaining items under the food and even under the non-food category there would be a difference in the percentage share in MPCE and the weights assigned in the CPI basket. The consumption pattern of the average Indian has undergone a lot of change since 2012. The CPI basket needs to be aligned to reflect the current consumption pattern.

Also, the CPI basket has around 300 items out of which a few items like radio, CD, DVD, audio/video cassette, and trunk which are obsolete are still captured. Even though their weight in the basket is of less significance they no longer reflect the modern-day consumption pattern. This is another reason to update the basket. A new CPI series is needed to capture the modern-day pattern which will also include the role of the digital economy. Relying on an older basket will lead to less accurate policies.

The Household Consumption Expenditure Survey 2022-23 released in February 2024 was the first major survey-based data released since 2011-12. The data released would be used by policymakers and experts to gauge the income and expenditure level of households and how and where the money is being spent. This will also help in re-calibrating the poverty, GDP calculations, and the CPI series with probably less weightage to food and beverages and higher to services. It will take some time for the government to come up with new CPI series but the survey will surely help in effective decision making.

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MOSPI