Why in the News
Concerns have been raised recently over the urgent need to update the Consumer Price Index (CPI), after the latest retail inflation data revealed a statistical anomaly that distorted the inflation picture.
Background / Context
Consumer Price Index (CPI) serves as primary measure of retail inflation, tracking price changes in basket of goods and services consumed by households.
- Retail inflation for October was recorded at 0.25%, lowest since January 2012.
- Deeper analysis has shown that fall to be statistical anomaly rather than genuine decline in price levels.
- Food and beverages category registered decline of 3.7%, largest fall in current CPI series.
- Inflation fall was driven largely by base-effect resulting from food inflation of 9.7% in same month of previous year.
- Due to large weight of food and beverages in CPI basket, approximately 46%, overall index was pulled down.
Key Issues Highlighted in the CPI Data
Food Inflation and Base-Effect
- Food inflation in October previous year had been 9.7%, creating high base.
- Because of high base, food inflation in October this year turned negative despite reports of rising vegetable prices in markets.
- With food weight near 46%, overall CPI was substantially affected.
Other Sub-Groups Behaviour
- Inflation in fuel and light, housing, tobacco, and miscellaneous categories was higher in October this year compared with previous year.
- GST rate cuts impact has been observed mainly in clothing and footwear category, which along with food, was among few categories showing lower inflation.
Perception versus Measured Inflation
- Perceived inflation as reported in RBI household survey for September stood at 7.4%, substantially higher than measured CPI figure, indicating disconnect between measurement and lived experience.
Implications for Monetary Policy
CPI as MPC Benchmark
- CPI is used as benchmark by Monetary Policy Committee (MPC) for interest rate decisions.
- MPC will face decision at December meeting on whether to keep rates unchanged or to cut rates, with CPI anomaly complicating judgement.
Growth Data Complication
- Growth estimates are being clouded by temporary demand boost from GST rate cuts, adding further complexity to MPC deliberations alongside anomalous CPI readings.
Assessment of CPI Methodology
Outdated Base Year and Weightages
- CPI base year remains 2012, causing misalignment with current consumption patterns.
- Weightages used in CPI basket are identified as inaccurate, leading to obscured rather than clarified inflation dynamics.
Statistical Robustness
- Large swings due to base-effect indicate need for better statistical safeguards to avoid misleading signals.
Government Response and Timeline
- Ministry of Statistics and Programme Implementation (MoSPI) has stated that new CPI series will be ready by first quarter of next financial year.
- Urgency for update has been emphasised given policy reliance on CPI.
Way Forward
To modernize CPI and ensure robust economic policymaking, comprehensive reforms must be prioritized, integrating technological advancements and stakeholder inputs for accuracy and relevance:
Structural Overhaul of CPI Framework
- Update base year urgently: Shift to recent year (2022-23) capturing post-pandemic shifts, reducing base effects and aligning with current consumption patterns.
- Revise weightages dynamically: Reduce food dominance (46%) by incorporating non-food items like digital services, education, and healthcare, using Household Consumption Expenditure Survey (HCES) data for precision.
- Incorporate core inflation metrics: Develop hybrid indices blending headline CPI with core measures (excluding volatiles), aiding MPC in distinguishing transient anomalies from persistent trends.
Technological and Methodological Enhancements
- Leverage big data and AI: Integrate real-time sources like e-commerce platforms, scanner data, and mobile apps for granular price tracking, minimizing survey biases and perception gaps.
- Conduct frequent reviews: Mandate annual weightage adjustments via NSO–RBI collaboration, ensuring adaptability to structural changes like urbanization or GST impacts.
- Pilot alternative indices: Test CPI variants (e.g., urban–rural specific) to address regional disparities, supporting targeted policies for inclusive growth.
Institutional and Policy Coordination
- Strengthen inter-agency synergy: Form joint task force involving MoSPI, RBI, and NITI Aayog for seamless revisions, with timelines enforced to avoid delays beyond Q1 next financial year.
- Enhance transparency and surveys: Expand RBI inflation expectation surveys to diverse demographics, using results to validate CPI updates and build public trust.
- Link to broader reforms: Align CPI revamp with fiscal measures like GST rationalization and supply chain improvements, mitigating food volatility for stable monetary decisions.
Conclusion
- October inflation data starkly demonstrates CPI’s outdated framework, where statistical anomalies mask underlying price pressures and erode trust in economic indicators.
- Swift revision not merely technical necessity, but imperative for informed monetary policy, inclusive development, and bridging data-reality divide.
Inflation Management
Inflation management is the cornerstone of macroeconomic stability, with the Consumer Price Index (CPI) serving as the primary compass for Monetary Policy. However, its effectiveness is continually tested by outdated measurement methodologies, fundamental structural shifts in consumption, and the crucial need for Fiscal-Monetary Coordination.
Inflation Measurement and Targeting Framework
Concept: Inflation and CPI
- Inflation: The sustained increase in the general price level of goods and services, resulting in a fall in purchasing power.
- CPI (Consumer Price Index): Measures the average change over time in the prices paid by urban and/or rural consumers for a fixed “basket” of goods and services.
- Headline CPI: Includes all items, prominently Food and Fuel. This is often the operational target in developing economies (e.g., India, where food has a high weight, 46%).
- Core CPI: Excludes volatile items (food and energy). It reveals the underlying, persistent demand-side inflationary pressure and is the preferred target in many advanced economies (e.g., the US Federal Reserve uses Core PCE, a related index).
Recent Data & Analytical Insight
- Global Disinflation: Following the sharp post-pandemic surge (peaking in 2022), global headline inflation has steadily declined, but Core CPI/Services inflation remains “sticky” (IMF, 2024-2025 forecasts), complicating the move towards the typical 2% target in advanced economies.
- Volatile Emerging Markets: In some major emerging economies, headline CPI has seen sharp volatility. For example, recent data (October 2025) indicated a drop to a series low of 0.25% in one such economy, driven largely by a sharp negative food inflation (deflation) and favourable base effects from a high inflation print a year prior
Role of CPI in Monetary Policy
Monetary Policy: Inflation Targeting (IT)
- Framework: IT is an operational regime where a central bank (e.g., the RBI) is mandated to maintain the CPI rate within a specified target band (e.g., 4%, with a tolerance band of plus or minus 2% points.
- Significance:
- Anchoring Expectations: A credible CPI target successfully anchors public and business inflation expectations, which is crucial because expectations are a key driver of future inflation (Wage-Price Spiral).
- Interest Rate Tool: CPI data directly dictates the central bank’s policy interest rate (e.g., the Repo Rate). If the forecasted CPI is expected to breach the upper target limit, the central bank raises rates to suppress aggregate demand.
Government (Fiscal) Policies in Coordination
When inflation is driven by supply-side factors (like food or oil price shocks), monetary policy is less effective and must be supported by government actions:
- Supply Management (Administrative): The government uses buffer stocks (e.g., releasing food grains), imposes stock limits on traders, and regulates exports/imports (e.g., banning onion exports or reducing import duties on pulses) to directly boost domestic supply and cool volatile food prices.
- Tax/Subsidy Adjustments (Fiscal): Reductions in indirect taxes (like GST or excise duty on fuel) have a direct, immediate, and visible impact on the CPI. For example, recent GST rate rationalisation contributed significantly to the low October 2025 CPI print mentioned above.
Base Year Revisions and Fiscal-Monetary Coordination
Concept of Base Year Revision
- The CPI’s “basket of goods” and the weight assigned to each item are fixed based on a Household Consumption Expenditure Survey (HCES) conducted in a Base Year.
- A Base Year Revision involves updating this reference year and the associated consumption weights to reflect contemporary spending patterns.
Impact on Coordination
Base year revisions lead to a more representative CPI, which enhances policy coordination:
| Aspect | Impact of Revised CPI |
| Monetary Policy Clarity | A modern CPI better reflects the true cost of living. If the old CPI overstated volatile food prices, the new one provides a clearer picture of Core Inflation, guiding the central bank to focus on sustainable demand management rather than overreacting to short-term supply shocks. |
| Fiscal Indicators | The revision often updates the base year for GDP/GVA measurement. A higher, more accurate nominal GDP (the denominator for fiscal ratios) can make the government’s Fiscal Deficit-to-GDP ratio appear more manageable, reducing pressure on the central bank to tighten policy excessively. |
| Shared Reality | Both authorities operate with a more accurate and common understanding of economic reality. This is crucial for formalising the inflation-growth trade-off and achieving policy alignment. |
Key Challenges in CPI Measurement and Inflation Targeting
The core difficulty lies in ensuring the Consumer Price Index (CPI) accurately reflects the true cost of living and in managing volatile prices that are beyond the direct control of interest rate policy.
A. Measurement and Statistical Challenges
These challenges relate to the CPI’s methodology and its ability to accurately track the consumer’s cost of living in a modern economy.
- Substitution Bias and Outdated Weights: The CPI often uses a fixed-weight formula (a Laspeyres index) based on an outdated Base Year (e.g., 2012). This fails to account for consumers substituting expensive goods with cheaper alternatives when prices rise, causing the CPI to overstate the true increase in the cost of living.
- Difficulty with Service Sector Prices: As economies mature, spending shifts from goods to services (healthcare, education, digital content). Measuring inflation here is complex because accurately adjusting prices for quality improvements is inherently difficult, leading to potential measurement bias (the hedonic adjustment challenge).
- Digitalization and E-commerce: Traditional, physical price collection methods struggle to capture the pricing reality of online shopping, which features dynamic pricing, frequent flash sales, and higher-quality imported goods. This creates a gap between reported CPI and actual market prices.
- New Goods Problem: Innovative, high-utility products are often excluded from the CPI basket for years until the next major revision, missing the crucial early period of rapid price declines and wide diffusion.
- Skewed Weightages (Emerging Markets): In many developing economies, the CPI’s large weight assigned to Food and Beverages (e.g., close to 46%) makes the headline inflation figure excessively volatile and highly susceptible to non-monetary, supply-side shocks (e.g., poor monsoons, agricultural disruptions)
B. Policy and Institutional Challenges
These challenges relate to the efficacy of the Monetary Policy framework and its coordination with the Government (Fiscal Policy).
- Supply-Side Policy Dilemma: Central banks primarily use interest rates to manage aggregate demand. When inflation is driven by supply shocks (food, fuel), aggressive rate hikes may curb demand but won’t solve the supply problem, risking an unnecessary stifling of economic growth (growth-inflation trade-off).
- Unanchored Expectations: In markets with high price volatility, public and business inflation expectations often become unanchored from the central bank’s medium-term target, driven instead by current high headline prices (especially food). This can lead to a destabilizing wage-price spiral.
- Fiscal Dominance Risk: If the government runs large, persistent fiscal deficits and resorts to high borrowing, the resulting surge in aggregate demand and debt pressure can undermine the central bank’s efforts to control inflation, compromising the independence and effectiveness of the Inflation Targeting framework.
Way Forward
The path to more effective inflation management involves statistical reform, technological adoption, and institutional enhancement based on global experience.
A. Enhancing CPI Measurement (Statistical Reforms)
| Best Practice | Description | Rationale |
| Frequent Base Year Revision | Conduct the Household Consumption Expenditure Survey (HCES) and revise the Base Year more frequently (e.g., every five years instead of ten or more). | Ensures the CPI basket and weights reflect current structural consumption shifts, reducing long-term substitution bias. |
| Chained Price Indices | Transition from the fixed-weight Laspeyres index (used in many Headline CPIs) to a Chained Price Index (e.g., the US’s PCE or Chain-weighted CPI). | Reduces substitution bias by updating weights annually or quarterly, allowing consumers’ price-driven substitutions to be captured sooner. |
| Integrate High-Frequency Data | Utilize Big Data sources like retail scanner data (Point-of-Sale records) and web-scraping for price collection. | Provides near real-time, high-granularity data, better capturing dynamic pricing and the impact of e-commerce. |
| Hedonic Adjustments | Employ sophisticated statistical techniques like hedonic regression to adjust for quality changes in products (especially technology and services). | Isolates the pure price change from the change in quality, improving the accuracy of inflation measurement. |
B. Strengthening the Policy Framework and Coordination
- Adopt Flexible Inflation Targeting (FIT): Central banks should formally adopt FIT, where they commit to achieving the target over a medium-term horizon (e.g., 2–3 years), rather than rigidly month-to-month.
- Significance: This allows policymakers to “look through” temporary, self-correcting supply shocks (food, fuel) without overreacting and causing unnecessary economic slowdown.
- Formalize Fiscal-Monetary Coordination: Establish transparent institutional mechanisms where the Ministry of Finance (Fiscal) and the Central Bank (Monetary) regularly consult on macroeconomic forecasts and policy actions.
- Goal: Ensures Fiscal Policy (e.g., buffer stock releases, tax/duty adjustments) actively supports the disinflationary objective, especially against supply shocks, preventing policy conflict.
- Enhance Communication and Transparency: The central bank must clearly communicate its target index (Headline vs. Core), the reasons behind its policy decisions, and the expected path of inflation.
- Impact: Builds policy credibility and helps anchor public inflation expectations to the target rather than current volatile prices.
- Target Core Inflation for Policy Stance: While many emerging economies must target Headline CPI for welfare reasons (due to the high food share), the central bank’s internal policy decision (rate setting) should heavily rely on Core CPI to gauge the underlying, persistent demand pressure.
Conclusion
- Accurate inflation measurement is the backbone of credible monetary policy and effective fiscal planning.
- CPI’s role as the anchor for inflation targeting remains indispensable, but rapid shifts in consumption, new digital goods, and volatile global commodity cycles require continuous refinement of the CPI basket, more frequent rebasing, and enhanced use of core inflation measures.
- Strong fiscal–monetary coordination, transparent communication, and global best practices—such as chain-weighting, trimmed-mean measures, and parallel series publication—are essential to ensure policy credibility.
UPSC MAINS PYQs
- Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments.
(2019)
