Inflation measurement is a serious business. Ask Sat Erdl Diner. For most of his term, the head of the Turkish Statistical Institute was under attack from the opposition for under-reporting inflation. Two months earlier, he was fired by Turkish President Recep Tayyip Erdogan because inflation figures were too high. According to Turkish news reports, Erdogan felt that those price hike figures presented an ineffective picture of the economy.
Thankfully, India’s inflation figures have not been politicized yet. But that doesn’t mean the country’s price-monitoring system is strong. Three major data issues affect the diagnosis and treatment of inflation in India. The first relates to the structure of the Consumer Price Index (CPI). The second issue is the absence of a Producer Price Index (PPI). The third is related to the Inflation Expectancy Survey conducted by the Reserve Bank of India (RBI).
The first of the three issues has received the most attention. Some economists have expressed apprehensions that our retail inflation gauge may not be in line with reality, as the CPI weighting is based on the National Sample Survey (NSS) Consumer Expenditure Survey for 2011-12. In particular, they worry that the heavy load of foods is distorting the index. They also point to some obsolete items in the ministry’s inflation-tracking basket, such as VCR cassettes, that are rarely used anymore.
This fear has increased to some extent. Old goods make up a small part of the inflation basket. A load of food may skew our inflation gauge, but not in the direction critics are pointing. The NSS Consumer Expenditure Survey for 2017-18 showed that the share of food in total consumption increased by 1.6 percentage points to 47.5% between 2011-12 and 2017-18. The survey results were annulled by the government because they showed a decline in rural consumption. If this is used to modify the CPI basket of tracked items, the food load goes up, not down. As people cut down on discretionary spending during the pandemic, the share of food in total consumption has only increased. So the ‘heavy’ load of food is not distorting the CPI index; If anything, its weight should be a little heavy.
A more serious issue is the lack of PPIs. Such an index tracks the price pressure on firms buying inputs. This can provide major indications on retail inflation. The lack of a PPI index hampers the Monetary Policy Committee (MPC) of the RBI, as it has to rely on a flawed proxy – the Wholesale Price Index (WPI). The use of WPI instead of PPI in the calculation of gross domestic product (GDP) is even more problematic, as it distorts the GDP deflator. In other countries, economists and policy makers may use the deflator as a comprehensive measure of inflation. In India, the GDP deflator is completely unreliable.
The most serious issue, as far as monetary policy is concerned, pertains to the RBI’s data on inflation expectations. One of the major functions of any central bank is to stabilize inflation expectations. This can be done only if it is measured correctly.
Central banks typically measure inflation expectations in two ways. The first is to calculate the underlying inflation expectation from the yield on inflation-linked bonds. The second is through household surveys, where people are explicitly asked about their inflation expectations. In the absence of inflation-linked bonds in the country, the RBI relies entirely on its inflation expectation survey. Roughly 6,000 respondents, spread across 18 cities, are interviewed every two months.
This sample is too narrow to draw any meaningful conclusions about inflation expectations in a vastly diverse country like India. Survey coverage and design have improved over the years but these changes are not enough. In 2012, the number of cities covered increased from 12 to 18. In 2014, the survey instrument was changed. In late 2018, the survey was redesigned to use a random sample for the first time; It was earlier based on ad hoc quota sampling. These changes also mean that survey data are not comparable over time. This means that the data is of limited use in forecasting, even though many analysts—including RBI’s own researchers—run time-series regression on this dataset without accounting for series breaks.
The biggest problem with the RBI survey is its lack of rural coverage. Its design is based primarily on household surveys conducted by Western central banks in urban economies. But India is mainly rural. It makes no sense to leave out the largest segment of a country’s population. It also deprives the central bank of valuable price information that food producers in rural areas have. This is especially important in an economy where food inflation accounts for about half of the index. RBI’s own Working Group on Surveys, set up by the then RBI Governor D. Subbarao in 2008, recommended that the survey be extended to rural areas.
RBI has a rich data legacy. The All India Credit and Investment Survey began life in 1951–52 as the Rural Credit Survey of the Reserve Bank of India. The next few rounds were also conducted by RBI before taking over the survey of NSS employees in the 1970s. The RBI had set up its data warehouse at a time when the statistics ministry was not even considering one.
The RBI’s Inflation Expectations Survey does not live up to that legacy. It needs to be overhauled. Only a largely nationally representative survey can provide an accurate measure of inflation expectations in India.
Prameet Bhattacharya is a Chennai based journalist. His Twitter handle is pramit_b. Is
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