India's Long-Overdue Consumer Price Index Update to Enhance Monetary Policy Accuracy
India is poised to receive a recalibrated inflation measure this week as part of a broader update of its economic statistics. The statistics ministry is scheduled to unveil a new consumer price index (CPI) that will replace the version in use for nearly 15 years. This significant overhaul will provide monetary policymakers with a clearer and more accurate view of household spending patterns, leading to steadier inflation data for economic management.
Reflecting Modern Household Spending Patterns
The weights in the new CPI will accurately reflect how Indian households currently allocate their monthly budgets across various spending categories, including food, housing, healthcare, and entertainment. These adjustments are based on data from the nationwide household expenditure survey conducted a couple of years ago, with the base year shifting to 2024 from the previous 2012 benchmark.
This update is particularly crucial because Indian monetary policy has been operating with outdated inflation measurements based on consumer spending data more than a decade old. The delay occurred when results from an earlier household consumer expenditure survey, originally due in 2019, were held back by the government citing data quality concerns.
Significant Reduction in Food Weightage
The most substantial change in the new CPI involves the weight assigned to food items, which will drop from 45.86% to 36.75%. This reduction reflects the economic reality that Indians are now spending a smaller portion of their household incomes on food as incomes have grown since 2012. International experience consistently shows that rising incomes lead households to allocate a smaller slice of their total income to food, while discretionary spending becomes relatively more important.
This fundamental shift in household spending structure carries two important consequences for monetary policy implementation. First, headline inflation will become more stable than before, since volatile food prices will have less impact on the overall CPI calculation. Second, it will enable the Monetary Policy Committee of the Reserve Bank of India to focus more attention on core inflation when analyzing price pressures within the economy.
Improved Inflation Stability and Policy Focus
Historical inflation data from the past decade reveals that headline inflation has shown approximately twice the volatility of core inflation when measured in terms of standard deviation. While core inflation has remained relatively stable within the 4-5% range since 2016, headline inflation has fluctuated between 1.3% and 7.5% during the same period.
The correlation coefficient between these two inflation measures has been 0.71, indicating that both have been influenced by common factors including demand conditions, monetary policy decisions, wage growth, profit markups, and broader economic cycles. However, the remaining divergence (the missing 0.29) occurs because food prices remain subject to supply shocks such as heat waves or global food price fluctuations that operate independently of domestic economic conditions.
A more stable headline inflation that moves in greater sync with core inflation will allow monetary policymakers to concentrate on the state of demand within the economy rather than reacting to temporary supply shocks. Modern monetary policy frameworks are better equipped to address demand-side factors than supply-side disruptions.
Alternative Measurement Approaches
Economists Ravindra H. Dholakia and Sri Virinchi S. Kadiyala have proposed an interesting alternative approach to measuring consumer price inflation in a recent paper published in Economic and Political Weekly. They advocate for an inflation measure based on national income accounts used to calculate gross domestic product quarterly, rather than relying solely on household expenditure survey data collected once every decade or more.
Their "counterfactual CPI" calculation assigns food an even lower weightage of 31% compared to the 36.75% in the upcoming official CPI revision. The economists argue that their alternative approach would enable government statisticians to implement a chain-based index of consumer prices, where weights assigned to various items adjust dynamically rather than undergoing massive adjustments every decade.
A chain-weighted CPI would regularly update the basket of goods and their corresponding weights based on what consumers are actually purchasing at any given time, rather than relying on a fixed basket from a base year as the current system does. This approach would prevent the index from overstating inflation by accounting for consumer behavior shifts toward relatively cheaper substitutes when prices increase.
Broader Economic Implications
While the transition to a new official CPI and discussions about inflation measurement methodologies might appear as abstract statistical debates, they carry far-reaching consequences for the country's interest rate policy that directly affects consumers, borrowers, investors, and corporations. Accurate inflation measurement forms the foundation of effective monetary policy decisions that shape economic stability and growth prospects.
The updated CPI represents a significant step toward aligning India's inflation measurement with contemporary economic realities, providing monetary authorities with better tools to maintain price stability while supporting sustainable economic development.
