Revising the consumption basket

Changing the components of the consumer price index is a detail-oriented exercise that requires the attention of all stakeholders

Food inflation continues to be in the news. A research article published in the Reserve Bank of India’s (RBI) January 2024 monthly bulletin made a strong case for understanding the behaviour of food inflation and why it needs to be taken into account for the conduct of monetary policy. Speaking after the meeting of the Monetary Policy Committee in August 2024, the Governor of the RBI opined that “food inflation pressures cannot be ignored”. For reasons outlined below, discussions on food inflation will become more nuanced once the consumption basket is revised in line with the patterns observed in India’s Household Consumption Expenditure Survey (HCES) 2022-23.

The consumption basket

The consumer price index (CPI) is the ratio of the value of consuming a fixed basket at today’s prices to that of the same basket at a past reference period, known as the “base year”. To ensure meaningful cross-country comparisons of inflation rates, National Statistical Offices around the world, including India, follow the manuals on constructing and revising important indices, including the CPI, prepared by the Intersecretariat Working Group on Price Statistics (IWGPS), which includes multilateral institutions as members.

The current CPI basket reflects the consumption pattern observed in HCES 2011-12. With the release of data from HCES 2022-23, the basket of goods whose prices would be tracked will be revised. The rural CPI basket comprises the following groups: Food and beverages, pan, tobacco and intoxicants, clothing and footwear, fuel and light, and miscellaneous. Unlike the rural CPI, the urban CPI basket includes housing rent. The revised CPI basket will reflect the consumption patterns evident in HCES 2022-23. 

Importance of CPI

Measuring inflation precisely is of utmost importance to the RBI, which is mandated to target an inflation rate of 4 per cent, plus or minus 2 per cent. The higher the inflation, the higher would be the nominal interest rate or yields in the secondary debt market. Further, with the inclusion of Government of India bonds in the JP Morgan Government Bond Index–Emerging Market, there is increased global interest in India’s macroeconomic indicators. The CPI is also constructed for each Indian state and major urban centres. The CPI basket reflects the inflation experience of the universe of households covered in HCES. Subject to availability of data, it is possible to construct CPI for sub groups of population like the elderly who have a different consumption basket, or construct an index based on online prices.

Change in the food basket

Over the period from 2011-12 to 2022-23, the share of food in monthly per capita consumption expenditure (MPCE) declined from 52.90 to 46.38 per cent in rural and from 42.62 to 39.17 per cent in urban India. In rural India, the share of cereal declined from 10.69 to 4.89 per cent and pulses and pulse products from 2.76 to 1.77 per cent over this period. In urban India, the share of cereal declined from 6.61 to 3.62 per cent and pulses and pulse products from 1.93 to 1.21 per cent in the same period. Because households got free rice, wheat and coarse grains from the public distribution system (PDS), the decline in value share was more pronounced than the decline in quantity consumed. In 2022-23, a person consumed 9.6 kg and 8.0 kg of cereals in rural and urban India, respectively, in a month, compared to 11.2 and 9.3 kg in 2011-12. Given that the share of items consumed free from PDS in the index is 0.80 in rural India and 0.25 in urban India, there is no reason to expect that consumption from the PDS would have any effect on inflation per se.

It is equally important to focus on other components of the food basket. The importance of beverages and processed food has crept up steadily over time. In 2022-23, its share in the overall rural and urban MPCE was 9.62 and 10.64, respectively, compared to 7.4 and 8.03 per cent in 2009-10. Hence, accurate measurement of the price of cooked meals and snacks purchased is now extremely important. For the first time, in both rural and urban India, the share of beverages and processed food in the consumption basket is more than the share of spending on milk and milk products. In urban India, the share of spending on cereals, vegetables and fruit is comparable to that of beverages and processed food. This implies that any discussion on food inflation will no longer have a singular focus on the prices of fruit and vegetables.

Devil lies in the details

Chapter 11 of IWGPS’ manual is worth a read, as it talks about tackling many interesting scenarios such as free items, seasonal products that are imported when out of season, internet purchases, owner-occupied housing services, second-hand goods, and own-account production. What is the price of an item that is part of the CPI basket but is provided free to the households? Since food grains are distributed for free through the PDS, their weight will be distributed to the other paid cereal items in proportion to the importance of each of them. In the future, if consumption from PDS is no longer free, the redistribution of the weights to other cereal items will be discontinued. However, it is far from obvious how one should account for the receipt of free health services under government schemes or free education.  Many judgement calls will go into the revision of India’s CPI basket and in determining the sources from which price information will be collected. Whether it is the RBI, bond traders, or foreign investors, they need to pay attention to how each cog in the CPI wheel will be fine-tuned.

The writers are, respectively, professor, Indira Gandhi Institute of Development Research, Mumbai,  and deputy director general, survey design & research division, National Sample Survey Office, Kolkata. The views are personal