Q1. Critically examine the limitations of India’s current Consumer Price Index (CPI) and explain why an urgent revision is essential for accurate inflation measurement and monetary policymaking.
Analytical Focus for Answer (AFfA):
- Outdated base year (2012) misaligned with post-GST, digital-economy, urban-consumption realities.
- Distorted weights → excessive food share; under-representation of services and digital consumption.
- Statistical anomalies (e.g., base effects in food inflation) causing misleading headline inflation.
- CPI–perceived inflation gap and its implications for households.
- Impact on RBI’s inflation targeting and MPC rate decisions.
- How mismeasurement leads to policy miscalibration (growth-inflation trade-off confusion).
- Urgency for timely adoption of the revised series.
Model Answer
Introduction
The Consumer Price Index is central to India’s monetary-policy framework and serves as the reference for welfare indexation and real-income evaluation. Yet the present CPI, anchored in a 2012 base year, struggles to reflect a rapidly transforming economy marked by rising service consumption, digital transactions and post-GST price structures. This disconnect has created statistical anomalies and widened the gap between measured and perceived inflation, making revision an urgent necessity.
Body
1. Structural Weaknesses in the Current CPI
- Outdated Consumption Structure: The 2012 basket does not capture GST-induced price restructuring or digital-era consumption.
- Excessive Food Weight: A disproportionately high food share magnifies volatility and masks inflation in non-food sectors.
- Inadequate Services Coverage: Education, health, telecom and transport inflation remain understated due to weak representation.
- Weak Housing Representation: The housing index fails to reflect dynamic rental trends in fast-urbanising regions.
2. Statistical Distortions and Measurement Gaps
- Base-Effect Distortion: High food inflation in the previous year creates artificially low inflation today, misleading policymakers.
- Headline–Reality Mismatch: A low CPI print coexists with rising prices in fuel, housing and miscellaneous services.
- Perceptual Inflation Gap: Household surveys reporting much higher perceived inflation indicate erosion of CPI credibility.
3. Policy Implications of an Outdated CPI
- Risk of Policy Misjudgment: An understated CPI may lead to premature rate cuts or inadequate tightening.
- Distorted Real Incomes: Inaccurate CPI inflates real-income estimates and weakens the rationale behind wage and DA adjustments.
- Weaker Welfare Targeting: Schemes indexed to CPI risk undercompensating vulnerable groups.
Conclusion
India’s current CPI no longer mirrors contemporary economic and consumption realities. A timely revision of the base year, weights and service coverage is essential to restore accuracy, support prudent monetary policy and ensure that welfare mechanisms remain aligned with actual household inflation.
Q2. Discuss the structural and methodological reforms required to make India’s CPI a more credible and representative measure of inflation in a rapidly transforming economy.
Analytical Focus for Answer (AFfA)
- Need for updated basket and weights reflecting new consumption patterns (services, urbanisation, electronics, digital spending).
- Integration of GST-era price and tax data for realistic relative prices.
- Improved sampling design: more towns, emerging urban clusters, e-commerce and online price collection.
- Overhaul of housing index to capture actual rental dynamics.
- Development of services and producer price indices to complement CPI.
- Benefits for national accounts, welfare schemes, indexation, and inflation expectations.
- Importance of revising CPI base every 3–5 years in line with global best practices.
Model Answer
Introduction
The credibility of any inflation index depends on its ability to capture evolving consumption behaviour and emerging price structures. India’s shift towards services, digital platforms, diversified retail chains and GST-based taxation has created a new economic landscape. A modern CPI requires broad methodological reform to mirror these structural changes accurately. Strengthening CPI architecture is crucial for improving inflation targeting, welfare indexation and macroeconomic analysis.
Body
1. Reforms in Base Year, Basket and Weights
- Adoption of an Updated Base Year: Transition to 2024 aligns measurement with current consumption realities.
- Reconstruction of Item Basket: Inclusion of digital services, subscription platforms and modern appliances reflects contemporary expenditure.
- Rationalisation of Weights: Lowering food weights and raising service weights ensures balanced inflation measurement.
2. Improvements in Price Collection and Market Coverage
- Integration of E-Commerce Prices: Captures the growing share of online transactions across urban India.
- Expansion to New Urban Clusters: Updated sampling covers fast-growing peri-urban and tier-II markets.
- Upgraded Housing Index: Dynamic rental data strengthens representation of urban living costs.
3. Strengthening Service-Sector Representation
- Comprehensive Service Coverage: Health, education, telecom, logistics and digital utilities require systematic inclusion.
- Development of a Services Price Index: Complements CPI and better maps structural inflation in a service-led economy.
4. Leveraging GST-Era and Digital Data Sources
- Use of GST Invoice Databases: Enhances accuracy of price tracking and reduces sampling biases.
- Integration of Administrative Data: Enables cross-verification of price movements with tax and sectoral datasets.
5. Ensuring Transparency and Methodological Clarity
- Clear Disclosure Norms: Transparent rules for handling discounts, freebies and PDS supplies enhance credibility.
- Public Methodology Papers: Strengthen academic scrutiny and improve public trust.
6. Institutionalising Regular Rebasing
- Periodic Base-Year Revision: Revising CPI every 3–5 years keeps the index aligned with evolving consumption patterns.
- Alignment with Global Standards: Ensures international comparability of India’s inflation data.
Conclusion
India’s CPI must evolve through structural and methodological upgrades that reflect the economy’s new composition. A modernised index—supported by improved data sources, robust service coverage, updated weights and regular rebasing—will provide policymakers and households with a more accurate map of inflation pressures. Such reform is fundamental to sustaining macroeconomic stability in a rapidly transforming economy.