Why aren’t inflation indices in sync? (The Hindu)

Mains Paper 3: Economy
Prelims level: Inflation
Mains level: Uses of the Consumer Price Index-Industrial Workers for measuring inflation
Context:

• The Consumer Price Index-Industrial Workers (CPI-IW) has been compiled, maintained and disseminated by the Labour Bureau since its inception in October 1946, and is the oldest CPI available in the country.

Uses of the Consumer Price Index-Industrial Workers:

• Traditionally, the index has been used to measure the impact of the price rise on the cost of living for the common man.
• In particular, the dearness allowance paid to government/public sector employees and pensioners is adjusted by using the CPI-IW even today.
• The industrial and service sector workers, targeted in estimating the CPI-IW, are more likely to reside in urban areas than in rural areas.
• Thus, inflation based on the CPI-IW is expected to correlate strongly to the more recent CPI and CPI-Urban Consumers (CPI-U) measures disseminated by the Ministry of Statistics and Programme Implementation (MoSPI).
• This has been the case since the release of the CPI/CPI-U in January 2011, but not during last the 1.5 years.

Difference in numbers

• The CPI-IW inflation for December 2019 rose to 9.63 per cent as against 8.61 per cent in November 2019. The CPI-IW inflation has consistently been above 5 per cent since July 2018, only briefly slipping to 4.86 per cent in November 2018.
• The CPI-IW inflation reached its highest value this month since November 2013. At the same time, the CPI and CPI-U inflation numbers had been consistently below 4 per cent and 4.5 per cent, respectively, till September 2019. In January 2019, the CPI inflation was recorded at 1.97 per cent, while the CPI-U inflation was 2.91 per cent.
• The CPI inflation breached the RBI’s inflation target of 4 per cent in October 2019, with the latest numbers for December 2019 indicating CPI inflation at 7.35 per cent and CPI-U inflation at 7.46 per cent. These facts indicate a divergence between the CPI-U and CPI-IW inflation measures.
• The overall correlation between the two inflation measures since January 2014 is 0.64. If we split the period into sub-periods by imposing a break in March 2018, we find that the correlation between the two measures before March 2018 was 0.79, while since April 2018, this correlation turned negative before moving back to 0.46.

What caused this divergence post April 2018?

• Much has been written about the divergence between the Wholesale Price Index (WPI) and CPI inflation in the past. This is understandable, since these two indices differ substantially in their methodology, composition and target groups.
• A higher CPI coupled with a lower WPI, as seen in the last few months, may occur due to significant food inflation, which forms a large part of the CPI calculation.
• It may point to the weaker pricing power of industrial companies, resulting from structural weaknesses or inefficiencies in the supply chain.
• The recent sharp decline in the RBI’s forward-looking survey on capacity utilisation rates points to such structural issues.
• At the same time, it is difficult to imagine the CPI-IW and CPI-U divergence arising due to any such matters. In terms of basket composition and target population, they are quite similar.

What could be the reason for this sharp divergence?

• Both CPI-IW and CPI-U inflation are calculated from price data collected from various centres by the Labour Bureau and the MoSPI, respectively.
• Neither captures subjective or survey-based data, where individual differences in the perception of inflation could have created differences in the calculated numbers.
• A closer look at major sub-components used for both measures points to divergence in the clothing and housing components as drivers.
• The inflation in housing was above 26 per cent as per the CPI-IW from July 2018 to June 2019, easing to 12.14 per cent since July 2019.
• During the same period, housing inflation under the CPI-U saw a high of 8.3 per cent and has eased down to 4.3 per cent by December 2019.
• It seems the price adjustment since July 2017 for the house rent allowance, after the 7th Pay Commission’s recommendations, in the housing component of the CPI-U and CPI-IW has been quite uneven.
• Further, while inflation in clothing declined to a low of 1.8 per cent in July 2019 under the CPI-IW, it has declined at a much slower rate as per the the CPI-U, touching a low of 2.63 per cent in November 2019.
• Further, while the Labour Bureau uses data from 78 centres for measuring CPI-IW inflation, the CPI-U data has a much higher coverage of 1,114 markets from 310 towns across India. The base years for the CPI-IW (2001) and the CPI-U (2012) are also different.

Way forward:

• Thus, methodological differences may be driving the negative correlation between the two inflation numbers.
• The exact reasons for this divergence, it would not be appropriate to imply that the inflation dynamics for industrial workers are inherently different from those for other households in urban areas.
• This could imply that one of the indices is either inappropriate or not capturing what it should. This points to problems with the credibility of the numbers themselves.

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Prelims Questions:

Q1. With reference to the Cauvery Delta Region, consider the following statements:
1. The Tamil Nadu Assembly has recently passed a bill declaring the Cauvery Delta Region a Protected Special Agriculture Zone (PSAZ).
2. The more industrialized districts of Trichy, Ariyalur and Karur are not part of the Delta region geographically.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: A
Mains Questions:
Q1. If methodological or other issues can create such high differences between inflation estimates for a similar segment of the population, how does one know which numbers are to be trusted?