How to Include PDS Items and Free Social Transfers in the New Retail Inflation Index?

1. In December 2024, The Ministry of Statistics and Programme Implementation (MoSPI) is seeking expert advice on how to handle food items distributed under the Public Distribution System (PDS) and free social transfers in the new Consumer Price Index (CPI), which is used to calculate retail inflation in India.
2. The ministry is working on updating the CPI and is facing challenges about how to treat these "free" items in the index.

The Issue with Free PDS Items

1. The government provides free food grains and other essentials through the Public Distribution System (PDS) to vulnerable groups, like those below the poverty line (BPL) and under schemes like the Antyodaya Anna Yojana (AAY).
2. The CPI measures changes in the prices of goods and services, reflecting the cost of living.
3. But the problem is: PDS items are given for free, so they don’t have a price. This raises questions about how to include them in the CPI.
   1. Should the price of PDS items be treated as zero or should they be given some small value?
   2. How should free items affect the inflation measurement?

Challenges in CPI Calculation

1. Adjusting Prices Mid-Series: In the ongoing CPI series, the prices of PDS items change when the distribution is stopped or altered. For example, an item may go from being free (zero price) to being sold at a price (positive value).
2. This creates a problem in adjusting the CPI to reflect these price changes.
3. Inclusion in CPI Basket: The bigger question is whether free PDS items should even be included in the CPI basket at the beginning of the new CPI series.

Options for Handling Free PDS Items

1. Method 1 (Zero Price): One option is to assign a zero price to PDS items and then adjust their weight in the CPI basket during future updates.
2. Method 2 (Redistribution of Weight): Another approach is to redistribute the weight of free PDS items to other items in the same category (e.g., cereals). This method is currently used in the CPI, but it does not fully capture the economic impact of free food distribution.
3. Method 3 (Redistribute to All Items): A third option is to distribute the weight of free PDS items more broadly across all items in the CPI basket, which might better reflect their broader economic impact.

International Guidelines

1. UN and IMF Guidelines: According to the United Nations and International Monetary Fund (IMF), free items (like PDS food) should not be counted as part of inflation measurement because they do not involve any monetary transaction.
2. In simple terms, since people don’t spend money on them, they don’t really affect inflation.
3. The IMF suggests that the CPI should focus on measuring actual spending or monetary transactions, and therefore free items should not be included in the CPI basket.

Current Method in CPI

1. Redistribution of Weights: In the current CPI series, the costs of free PDS items are excluded from the index, and their weights are redistributed to other similar items (such as cereals or rice).
2. This approach is consistent with international best practices, but it does not fully account for the economic impact of free food grains on inflation.

MoSPI’s Discussion Paper

1. MoSPI has circulated a discussion paper inviting feedback on how to handle free PDS items in the new CPI index.
2. They are seeking expert opinions, as well as input from government bodies, academics, and the general public.
3. The goal is to make the CPI index more accurate and representative of how inflation affects Indian households, especially those who rely on free government food programs.

Next Steps and Deadlines

1. MoSPI plans to update the CPI and revise its base year from 2012 to 2024.
2. They will use data from the Household Consumption Expenditure Survey (HCES) 2022-23 to decide on the new weights and item basket.
3. The ministry has set a deadline for experts to submit their comments by January 15, 2025.

Why This Matters

1. The CPI is used by the Reserve Bank of India (RBI) to make decisions on monetary policy, including interest rates and inflation targets.
2. How free items are treated in the CPI could affect these decisions, influencing things like interest rates, government policies, and overall economic planning.
3. This debate also highlights the broader question of how to accurately measure inflation in a country with large-scale social welfare programs.

What is Consumer Price Index (CPI) ? The Consumer Price Index (CPI) is an economic indicator that measures inflation by tracking changes in the prices of goods and services typically purchased by households. Role: It monitors the cost of living, guides monetary and fiscal policies, and reflects the economic health of a country. Base Year Revision: The base year for CPI in India was revised from 2010=100 to 2012=100 for better accuracy in inflation measurement. Purpose of CPI Inflation Measurement: Measures how the prices of goods and services consumed by an average consumer increase over time. Purchasing Power: Reflects the change in purchasing power of money. When prices rise (inflation), the purchasing power decreases, meaning consumers can buy less with the same money. Macroeconomic Indicator: Used by governments, central banks (like the RBI), and financial institutions to assess the overall economic health. How is CPI Calculated? Basket of Goods and Services: The CPI calculation uses a fixed basket of goods and services that an average household purchases. This basket includes: Food, clothing, transportation Medical care, education, electricity, etc. Frequency of Updates: The basket is updated periodically to reflect changing consumer consumption patterns. Data Collection: Prices are collected from markets across urban and rural areas. CPI Formula CPI = (Cost of a Fixed Basket of Goods and Services in the Current Year/cost of a Fixed Basket of Goods and Services in the Base Year) * 100 Base Year: The base year is set as 100 for comparison. If CPI for a given year is 110, prices have risen by 10% compared to the base year. Importance of CPI Inflation Measurement: Helps track the rise in the cost of living and understand how much more expensive goods and services have become. Economic Policy Tool: The RBI uses CPI data to set monetary policies, including interest rates. High inflation might lead to higher interest rates to curb spending. Adjustments in Wages & Pensions: Used to adjust salaries, pensions, and allowances to maintain purchasing power in line with inflation. Deflators for National Accounts: CPI separates inflation effects from real economic growth in national accounts. How is CPI Used? Monetary Policy Decisions: The RBI uses CPI to determine if monetary tightening or loosening is needed to control inflation. Cost of Living Adjustments: Dearness Allowance (DA) for government employees is adjusted based on CPI to compensate for inflation. Investment Decisions: Investors use CPI to assess real returns. High inflation could reduce the value of fixed-income assets, whereas inflation-linked assets may become more attractive. Business & Consumer Decision-Making: Businesses adjust prices based on CPI. Rising CPI could lead to higher costs, pushing up prices for goods and services. Consumers adjust their budgets to cope with inflation. CPI and Inflation Inflation: A rise in the CPI indicates inflation, meaning the average price of goods has increased. Example: If CPI increases by 5% in a year, the average price of goods has increased by 5%. Deflation: If CPI shows negative growth, it indicates deflation (falling prices), which may lead to economic stagnation and reduced consumer spending in the long run.

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