Present CPI aggregation method raises issues for monetary policy: RBI paper

Rebasing CPI necessary to make index relevant to present consumption patterns

The method used by the National Statistics Office at present to aggregate the Consumer Price Index at times presents challenges for the conduct of monetary policy as the inflation captured by the index reflects data distortions, Reserve Bank of India staff wrote.

“The present method of horizontal aggregation of CPI, across sectors and States/UTs for all-India item level indices as well as for indices at sub-group/ group and overall, at times creates challenges for use of the index for monetary policy since the inflation based on it reflects, in addition to changes in prices of goods and services, data kinks that emanate from the aggregation methodology,” Praggya Das and Asish Thomas George, members of the RBI’s monetary policy department wrote.

The views, which were expressed in an article in the RBI’s March 2023 Bulletin are personal and do not reflect those of the central bank.

The article in the Bulletin comes amid criticism of the NSO’s data computation methods following the release of the February CPI inflation print, which showed the consumer price gauge at 6.44 per cent, much higher than the RBI’s target of 4 per cent and outside of its 2-6 per cent tolerance band.

In a March 14 note, State Bank of India’s group chief economist wrote that much of the data collated for inflation calculation had “innate structural issues”, with the figures distorted due to over-reliance on select non-essential parts. According to SBI’s report, the increase in cereal CPI was a statistical error and the NSO’s methods for calculating milk and milk product inflation were faulty.

Cereal inflation was a key factor driving the elevated CPI print in February, analyst said.

CPI inflation has stayed above 6 per cent for nine of the 11 months in the current financial year – even as the RBI has raised the policy repo rate by a total of 250 bps from May 2022 to February 2023.

Base year, price divergence

According to the authors, efforts should be made to conduct a new Consumer Expenditure Survey for rebasing the CPI to a recent period. This would make the CPI consumption basket relevant for the present household consumption behaviour and prevent instances of missing or thin price quotes.

“The current CPI base of 2012 is derived from the consumption expenditure survey conducted during 2011-2012. The market survey to identify shops for collecting prices is even older. . Timely base revision with synchronous CES, price and market survey every five years can address policy maker’s concerns,” the RBI staff wrote.

The all-India CPI series started from January 2011 with base 2010=100. The base was later revised to 2012 and the data for the new base series is available since January 2013, they wrote.

In a speech in November 2022, RBI Deputy Governor Michael Patra had also flagged issues surrounding the collection of key data used for policymaking.

Pointing out that inflation data came with a lag of one month and GDP data with a lag of three months, Patra had said that future forecasts were based on backward-looking information and could be thrown off course by unanticipated shocks.

In the Bulletin article, the authors also flagged issues concerning divergence between price indices stemming from missing prices and the treatment of a category referred to as “zero” prices.

“Divergence between price indices compiled by horizontal and vertical aggregation can arise mainly from two sources – missing prices (for seasonal or non-seasonal reasons) and treatment of zero price (as was seen in the January and February 2023 CPI prints),” the RBI staff wrote.

“The need to discuss the occurrence of missing and zero prices is crucial because in such case overall inflation derived through the vertical aggregation method by users can differ, and at times the divergence could be significant, from not only the published headline CPI inflation, but also for sub-group/group inflation,” the wrote.

The authors said that at present there was no guidance on the proper treatment of zero prices in the NSO’s CPI manual. Referring to the recent instant of PDS prices being reduced to zero, the authors said that based on international practices, such cases may be considered zero-prices and not missing prices.