India Needs Cost-Of-Living Index To Reflect People’s Inflation Experiences

Chennai: While Consumer Price Index numbers have remained moderate, the cost of essential commodities, education, healthcare and other services have seen significant rises. Rajni Thakur, chief economist, L&T Finance, finds that the inflation experience of different households is quite different from the headline numbers. This makes a case for two indices — one for tracking the cost of living and another for tracking an aggregate index for policy purposes.

According to Thakur, CPI is essentially an all-India average across different consumption baskets. Household consumption surveys determine how much households spend, or the share of expenditure devoted to particular items, while month-on-month price changes are captured and indexed to arrive at the CPI.

However, household consumption patterns are changing rapidly, creating a gap between headline inflation and the inflation experienced by individual households. Food, for instance, accounted for more than 50% of household consumption a couple of decades ago in both rural and urban areas. That share has now declined to around 36% and 47%, respectively.

At the same time, expenditure on education, rent, healthcare and out-of-pocket medical expenses has become more significant. Even within food, cereals are losing weight while beverages and packaged foods are gaining importance.

Thakur said the CPI weights are statistically derived and are appropriate for measuring aggregate price movements. However, the index cannot capture the experience of specific age groups, income groups or households. A young family with children, a retired household and a student can have vastly different consumption baskets and therefore experience inflation differently.

She said India also faces a trade-off over how frequently CPI weights should be revised. While countries such as the US revise weights annually and some other economies do so more frequently, India follows a five-year cycle. More frequent revisions could better capture changing consumption patterns, but would also involve higher administrative costs.

India could eventually make greater use of scanner data and online prices, as several advanced economies do. But Thakur said the country is not yet ready to rely on such data because a substantial share of consumption still takes place through neighbourhood markets and traditional retail channels.

She argued that India should consider introducing a separate cost-of-living index alongside the CPI. Such an index could capture inflation across different income groups, cities and states and provide more meaningful information for households as well as policymakers.

A more disaggregated index could also help monetary policymakers distinguish between temporary price volatility and more persistent inflationary pressures, potentially reducing the risk of overreacting to short-lived increases in food or other commodity prices.

Thakur suggested that India could also examine whether CPI weights should eventually be revised every two or three years rather than every five years. More robust and granular inflation data, she said, would improve monetary and fiscal policy making while helping households make better-informed decisions about wages, jobs and living costs