6. Economics Notes 29

Elaborate Notes

CPI- CONSUMER PRICE INDEX

The Consumer Price Index (CPI) is a crucial macroeconomic indicator that measures the average change over time in the prices paid by urban and rural consumers for a market basket of consumer goods and services. It is calculated on a monthly basis and serves as a primary measure of retail inflation and changes in the cost of living.

• Conceptual Framework: The CPI operates by tracking the price of a fixed basket of goods and services that represents the consumption patterns of a specific population group. The selection of items and their weights is based on consumer expenditure surveys. For instance, the current basket for CPI (Combined) is derived from the Consumer Expenditure Survey (CES) conducted by the National Sample Survey Office (NSSO) in 2011-12.
• Significance: It reflects the real-world price pressures faced by households, making it a more relatable measure of inflation than the Wholesale Price Index (WPI). Its inclusion of services (like education, healthcare, transport), which WPI omits, provides a more comprehensive view of the economy’s price level.

Various types of CPI

1. CPI for Industrial Workers (CPI-IW):

   • Purpose: This index is specifically designed to measure inflation’s impact on industrial workers. Its most significant application is in determining the Dearness Allowance (DA) and Dearness Relief (DR) for government employees, public sector undertaking employees, and pensioners. It is also used for fixing and revising minimum wages in scheduled employments.
   • Historical Context: The series originated during World War II to calculate cost of living allowances. The Labour Bureau has been compiling it since 1946. The base year was recently updated from 2001 to 2016 to reflect the changing consumption patterns of industrial workers.

2. CPI for Agricultural Labourers (CPI-AL):

   • Purpose: This index tracks the retail price variations of goods and services consumed by agricultural labourers. A primary use is the revision of minimum wages for agricultural labour across various states. It is also a key input for determining wages under the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA).
   • Base Year: The base year is 1986-87, which is considerably old and has been a subject of academic and policy debate regarding its representativeness of current rural consumption patterns.

3. CPI for Rural Labourers (CPI-RL):

   • Purpose: Similar to CPI-AL, this index focuses on the consumption basket of rural labourers as a whole, a slightly broader category than just agricultural labourers. It is also used for wage revisions in rural areas.
   • Base Year: It shares the same base year as CPI-AL, 1986-87.
   • Compiled By: Both CPI-AL and CPI-RL are compiled and released by the Labour Bureau, which operates under the Ministry of Labour and Employment.

4. CPI (Rural, Urban, and Combined):

   • Genesis: This is the most comprehensive and widely used CPI series in India. It was introduced in 2011 to provide separate indices for rural and urban populations, as well as a combined national index.
   • Compiled By: It is compiled by the National Statistical Office (NSO), Ministry of Statistics and Programme Implementation (MoSPI). The NSO was formed by the merger of the Central Statistics Office (CSO) and the National Sample Survey Office (NSSO).
   • Base Year: The current base year for this series is 2012. There are ongoing discussions to update the base year to a more recent period to better reflect contemporary consumption habits.
   • Basket Composition: The baskets are extensive, with 448 items for rural households and 460 items for urban households. This diversity ensures a broad coverage of consumer spending.
   • Policy Relevance: The Urjit Patel Committee (2014), constituted to review the monetary policy framework, recommended making CPI (Combined) the nominal anchor for monetary policy. Consequently, the Reserve Bank of India (RBI) and the Government of India formally adopted it for inflation targeting. The current mandated target is 4% with a tolerance band of +/- 2%. India’s headline inflation figure, which is widely reported, refers to the year-on-year percentage change in the CPI (Combined).

CPI WEIGHTAGE

The weightage assigned to different commodity groups in the CPI basket is crucial as it determines their relative influence on the overall index. These weights are derived from the average expenditure of a household on these items, as recorded in the Consumer Expenditure Survey.

Groups	Weightage (%)
(1) Food and Beverages	45.86
(2) Pan, tobacco, and intoxicants	2.38
(3) Clothing and footwear	6.53
(4) Housing (Urban only)	10.07
(5) Fuel and light	6.84
(6) Miscellaneous	28.32

• Headline vs. Core Inflation:

  • CPI Headline Inflation: This is the total inflation in the economy and is calculated using all the groups in the basket (Groups 1 through 6). It provides a picture of the overall cost of living.
  • CPI Core Inflation: This measure is derived by excluding the volatile components of the index, namely ‘Food and Beverages’ (Group 1) and ‘Fuel and Light’ (Group 5). The resulting index, comprising Groups 2, 3, 4, and 6, is considered a better indicator of the underlying, long-term inflation trend as it is less susceptible to temporary supply shocks.
  • CPI (Refined Core) Inflation: This is a further refinement of core inflation that also excludes fuel used in transportation (petrol and diesel), which is part of the ‘Miscellaneous’ group. This exclusion provides an even clearer view of demand-driven inflation by removing the impact of volatile global crude oil prices.

• Comparison between Rural and Urban CPI Weightage: The consumption patterns differ significantly between rural and urban areas, which is reflected in their respective CPI baskets.

Groups	Rural Weightage (%)	Urban Weightage (%)
Food and beverages	54.18	36.29
Pan, tobacco, and intoxicants	3.26	1.36
Clothing and footwear	7.36	5.57
Housing	-	21.67
Fuel and light	7.94	5.58
Miscellaneous	27.26	29.53

• Key Observations:
  • Food: Has a much higher weightage in the rural basket (54.18%) than in the urban basket (36.29%). This implies that food price inflation has a more pronounced impact on rural households.
  • Housing: This component is only included in the urban index, with a significant weight of 21.67%, as rental data for rural areas is not widely available or standardized.

RECENT TRENDS AND GOVERNMENT MEASURES

• Rural-Urban Inflation Gap: In the recent past, particularly in early 2022, many states witnessed higher rural inflation than urban inflation, driven largely by food prices. However, this gap narrowed during the fiscal year 2022-23 as global commodity prices, including food, began to cool off, and domestic supply-side measures took effect.
• Impact of Geopolitical Events: The Russia-Ukraine conflict in 2022 had a direct and significant impact on India’s CPI. India imports about 60% of its edible oil, and sunflower oil, which constitutes around 15% of these imports, is primarily sourced from Ukraine and Russia. The disruption in supply chains led to a sharp spike in edible oil prices, contributing substantially to food inflation.
• Government Interventions: To manage food inflation, the government has undertaken several supply-side measures:
  1. Pulses: Maintaining a buffer stock of pulses under the Price Stabilization Fund (PSF) to release into the market to cool prices during shortages.
  2. Edible Oils: The basic customs duty on crude and refined palm oil, soyabean oil, and sunflower oil was reduced multiple times. Additionally, stock limits were imposed on traders to prevent hoarding and speculation.
  3. Cereals: To ensure domestic availability and control prices, the government regulated the export of wheat flour and imposed an export duty of 20% on certain varieties of rice, including brown rice.

CONVERGENCE BETWEEN CPI AND WPI

Historically, a divergence has existed between WPI and CPI inflation rates due to fundamental differences in their composition, scope, and weightage.

• Structural Differences:

  • Scope: WPI measures inflation at the wholesale/producer level, while CPI measures it at the retail/consumer level.
  • Composition: WPI is dominated by manufactured goods and commodities, whereas CPI has a higher weight for food items. Critically, WPI does not include services, while services are a major component (under the ‘Miscellaneous’ group) of the CPI.
  • Price Transmission: International price shocks (e.g., in crude oil or metals) impact WPI first. This inflation is then passed on to retail prices (CPI) with a time lag, as manufacturers and retailers adjust their final prices.

• Factors Driving Recent Convergence:

  1. Services Inflation: The services sector, which is a core component of CPI but absent in WPI, experienced persistent inflation, keeping the CPI elevated even when WPI was falling.
  2. Cooling Commodity Prices: A global reduction in the prices of key industrial commodities like crude oil, steel, aluminum, and cotton led to a significant fall in WPI inflation. As this effect was transmitted to the retail level, it also helped moderate CPI, contributing to the convergence of the two indices.

• Inflationary Expectations and Monetary Policy:

  • Credibility: The effectiveness of monetary policy hinges on anchoring inflationary expectations. When households and businesses trust that the central bank (RBI) will successfully control inflation in the long run, they are less likely to make decisions (e.g., demanding higher wages or raising prices) that perpetuate inflation.
  • Soft Landing vs. Hard Landing:
    • Monetary Tightening: The RBI’s recent policies, such as increasing the Repo Rate and the Cash Reserve Ratio (CRR), were aimed at reducing liquidity to curb demand-pull inflation.
    • Soft Landing: This refers to a scenario where monetary tightening successfully brings down inflation without causing a significant economic slowdown or recession. India’s resilient growth despite policy tightening suggests a successful soft landing is underway.
    • Hard Landing: This occurs when aggressive tightening leads to a sharp contraction in economic activity and a recession. This was a significant challenge for many developed countries in the 1970s and 1990s. The classic example is the “Volcker Shock” in the early 1980s in the USA, where Federal Reserve Chairman Paul Volcker’s drastic interest rate hikes crushed inflation but also triggered a severe recession.

BASIC TERMS RELATED TO PRICE LEVELS

• Deflation: A sustained decrease in the general price level of goods and services, corresponding to a negative inflation rate. It is considered more dangerous than inflation because it can lead to a vicious cycle: falling prices cause consumers to postpone purchases, leading to lower production, higher unemployment, and further price drops. The “Lost Decade” in Japan during the 1990s is a prime example of a prolonged deflationary period.
• Disinflation: A slowdown in the rate of price inflation. During disinflation, the inflation rate is still positive but is declining over time. For example, if the annual inflation rate falls from 7% in one quarter to 5% in the next, the economy is experiencing disinflation.
• Stagflation: A portmanteau of stagnation and inflation, this describes a period of high inflation combined with high unemployment and stagnant economic growth (low or negative GDP growth). This phenomenon challenges the traditional Phillips Curve theory, which posits an inverse relationship between inflation and unemployment. The most cited example is the US economy in the 1970s, which was hit by OPEC oil price shocks, leading to simultaneous inflation and economic stagnation.
• Reflation: A policy-induced increase in the general price level to counteract deflationary pressures. It signifies an economic recovery phase following a recession or downturn. Governments and central banks may use expansionary fiscal policy (tax cuts, increased spending) and monetary policy (quantitative easing) to stimulate demand and lift prices back to a healthy level.
• Skewflation: A situation where there is a significant price rise in a specific group of commodities (e.g., food items) while prices for other goods and services remain stable or even fall. This “skewed” inflation pattern creates distortions in the economy and disproportionately affects certain sections of the population. The term was notably used by former Chief Economic Adviser Kaushik Basu in the context of India’s high food inflation in the late 2000s.
• GDP Deflator: An index that measures the change in the average price level of all new, domestically produced, final goods and services in an economy.
  • Formula: GDP Deflator = (Nominal GDP / Real GDP) * 100.
  • Interpretation: If the deflator is greater than 100, it indicates inflation since the base year. If it is less than 100, it indicates deflation.
  • Scope: It is the most comprehensive measure of inflation as it covers the entire spectrum of economic output, including goods and services not tracked by CPI or WPI. However, it is not used for real-time policy-making because GDP data is available only on a quarterly or annual basis, unlike the monthly frequency of CPI and WPI.

POVERTY

Poverty is a multidimensional phenomenon characterized by the severe deprivation of basic human needs, including food, safe drinking water, sanitation facilities, health, shelter, education, and information. It is not merely a lack of income but also a denial of opportunities and choices fundamental to human development.

CONCEPT OF ABSOLUTE POVERTY

• Definition: Absolute poverty refers to a condition where a household’s income or consumption expenditure is below a certain minimum level necessary to meet basic subsistence needs. This minimum level is known as the poverty line.
• Methodology:
  1. Poverty Line Basket (PLB): A basket of goods and services (primarily food items to meet a minimum calorie norm, along with some non-food essentials) considered essential for survival is determined.
  2. Monetary Value: The quantities in this basket are then valued at current market prices to arrive at a per capita monetary figure—the poverty line.
  3. Identification: Individuals or households whose per capita consumption expenditure falls below this line are classified as Below Poverty Line (BPL).
• Headcount Ratio (HCR): This is the most common measure of absolute poverty. It is the proportion of a country’s population living below the poverty line.
  • Formula: HCR = (Number of poor people / Total population) * 100.
  • Limitation: The HCR only measures the incidence (or spread) of poverty. It does not provide information about how poor the poor are (the depth or intensity of poverty). For example, it treats a person just below the poverty line the same as a person far below it.
• Consumption vs. Income: In India and many developing countries, poverty is measured based on consumption expenditure rather than income for several reasons:
  • Data Reliability: Income data, especially for the self-employed or those in the informal sector, is often irregular and difficult to collect accurately. Consumption data tends to be more stable and easier to recall.
  • Inclusivity: Consumption reflects the actual standard of living and includes non-earning dependents like children and the elderly.
  • Consumption Smoothing: Households may use savings or borrowings to maintain their consumption levels even when their income fluctuates, making consumption a better long-term indicator of welfare.

POVERTY GAP RATIO (PGR)

• Definition: The Poverty Gap Ratio measures the depth of poverty. It represents the average shortfall of the poor’s consumption expenditure from the poverty line, expressed as a percentage of the poverty line. It essentially indicates how much money, on average, would be needed to bring every poor person up to the poverty line.
• Formula: PGR = [(Poverty Line - Average per capita expenditure of BPL households) / Poverty Line] * 100.
• Significance: A higher PGR implies that poverty is deeper and more entrenched. This metric is useful for policymakers as it helps estimate the minimum financial resources required to eliminate poverty through targeted cash transfers.

SQUARED POVERTY GAP INDEX (SPGI)

• Definition: Developed by economists James Foster, Joel Greer, and Erik Thorbecke (1984) as part of their FGT class of poverty measures, the SPGI measures the severity of poverty. It not only considers the distance of the poor from the poverty line (like the PGR) but also gives higher weight to those who are furthest below the line.
• Methodology: It is calculated by averaging the square of the poverty gap for each poor individual. By squaring the gap, the index disproportionately increases the weight of the poorest individuals, thereby accounting for inequality among the poor.
• Significance: The SPGI is sensitive to the distribution of consumption among the poor. In the example provided in the summary, although countries A and B have the same HCR and PGR, the SPGI for country A would be significantly higher because of the extreme poverty of one individual (PCI=10) compared to country B. This makes SPGI a powerful tool for designing policies that prioritize the most vulnerable and destitute.

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Prelims Pointers

• CPI (Consumer Price Index): Measures retail price changes monthly for goods and services.
• CPI (Industrial Workers - IW):
  • Base Year: 2016
  • Compiled by: Labour Bureau (Ministry of Labour and Employment)
  • Use: Determines Dearness Allowance (DA) for government employees.
• CPI (Agricultural Labourers - AL):
  • Base Year: 1986-87
  • Compiled by: Labour Bureau
  • Use: Revises minimum wages for agricultural labour.
• CPI (Rural Labourers - RL):
  • Base Year: 1986-87
  • Compiled by: Labour Bureau
• CPI (Rural, Urban, Combined):
  • Base Year: 2012
  • Compiled by: National Statistical Office (NSO)
  • Items in basket: 448 (Rural), 460 (Urban).
• Inflation Targeting: RBI uses CPI (Combined) for monetary policy based on the Urjit Patel Committee recommendations.
• Headline Inflation: Based on the all-items CPI (Combined).
• Core Inflation: Headline CPI minus ‘Food and beverages’ and ‘Fuel and light’.
• CPI Weightages (Combined):
  • Food and Beverages: 45.86%
  • Housing: 10.07%
  • Miscellaneous: 28.32%
• Rural vs. Urban CPI Weightage: Food and beverages have a higher weight in rural (54.18%) than in urban (36.29%) baskets. Housing is only part of the urban basket.
• Russia-Ukraine Conflict Impact: Disrupted sunflower oil imports, which constitute 15% of India’s total edible oil imports, leading to a spike in edible oil prices.
• Soft Landing: Monetary tightening that controls inflation without causing a recession.
• Hard Landing: Monetary tightening that leads to a recession.
• Deflation: Sustained fall in the general price level (negative inflation).
• Disinflation: A decrease in the rate of inflation.
• Stagflation: High inflation, high unemployment, and stagnant economic growth.
• Reflation: Policy-driven recovery of prices after a period of deflation.
• Skewflation: Significant inflation in only a few commodities while others remain stable.
• GDP Deflator: Ratio of GDP at current prices (Nominal GDP) to GDP at constant prices (Real GDP). It is the most comprehensive inflation measure.
• Absolute Poverty: Measured against a fixed minimum level of consumption known as the poverty line.
• Headcount Ratio (HCR): Percentage of the population below the poverty line. Measures the incidence of poverty.
• Poverty Gap Ratio (PGR): Measures the average shortfall of the poor from the poverty line. Measures the depth of poverty.
• Squared Poverty Gap Index (SPGI): Measures poverty by giving higher weight to the poorest individuals. Measures the severity of poverty and inequality among the poor.

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Mains Insights

1. Shift to CPI for Monetary Policy (GS Paper III):

   • Rationale: The shift from WPI to CPI (Combined) as the nominal anchor for monetary policy, recommended by the Urjit Patel Committee (2014), was a paradigm shift. WPI, being a producer-side index, does not reflect the cost of living for the general populace and excludes the burgeoning services sector. CPI is more representative of household consumption patterns and thus a better target for a central bank focused on citizen welfare.
   • Implications: This shift has made monetary policy more effective in managing inflationary expectations. The Monetary Policy Committee (MPC) framework, with its explicit inflation target (4% +/- 2%), has enhanced the transparency and accountability of the RBI.
   • Debate: A key debate is whether the RBI should focus solely on inflation (as per the flexible inflation targeting framework) or also consider growth objectives. The concept of a “soft landing” reflects the delicate balancing act required to curb inflation without stifling economic recovery.

2. Dynamics of Indian Inflation (GS Paper III):

   • Supply-Side vs. Demand-Side: Indian inflation is often driven by supply-side shocks, especially in food and fuel (e.g., erratic monsoons, global oil price volatility). However, monetary policy tools (like the repo rate) are more effective at managing demand-side pressures. This creates a policy dilemma.
   • Cause-Effect Analysis: Global events, like the Russia-Ukraine conflict, directly impact India’s inflation through import channels (edible oils, fertilizers, crude oil). This underscores India’s vulnerability to external shocks and the need for strategic measures like import diversification and boosting domestic production (Atmanirbhar Bharat).
   • WPI-CPI Convergence: The convergence and divergence between WPI and CPI offer insights into economic trends. A large positive gap (WPI > CPI) often signals building pressure at the producer level that may soon be transmitted to consumers. Conversely, a negative gap (WPI < CPI), as seen recently, indicates that cooling commodity prices are helping moderate inflation, but sticky services inflation is keeping CPI elevated.

3. The Multidimensionality of Poverty and Measurement Challenges (GS Paper II & III):

   • Beyond the Calorie Norm: The consumption-based poverty line, often criticized as a “starvation line,” provides a very narrow view of poverty. It measures only the lack of resources to meet basic consumption needs.
   • Historiographical Viewpoint: The poverty estimation debate in India, from the Dandekar-Rath Committee (1971) to the Tendulkar (2009) and Rangarajan (2014) Committees, highlights the evolving understanding and political contestations surrounding poverty measurement.
   • Analytical Perspective: Moving from the Headcount Ratio (HCR) to the Poverty Gap Ratio (PGR) and Squared Poverty Gap Index (SPGI) represents an analytical progression.
     • HCR: Informs us “how many” are poor. Policy focus: Broad-based schemes.
     • PGR: Informs us “how poor” they are on average. Policy focus: Estimating financial outlay for poverty alleviation (e.g., through Direct Benefit Transfer).
     • SPGI: Informs us about the “severity” and inequality among the poor. Policy focus: Prioritizing the “poorest of the poor,” aligning with the principle of Antyodaya.
   • Modern Approaches: The use of multidimensional poverty indices (like the NITI Aayog’s National MPI), which include indicators for health, education, and living standards, aligns with Amartya Sen’s “Capability Approach” and provides a more holistic and actionable framework for poverty reduction policies.

4. Inflation’s Impact on Poverty and Inequality (GS Paper I & III):

   • Regressive Nature of Inflation: High inflation, particularly food inflation, acts as a regressive tax. It disproportionately harms the poor and low-income groups because they spend a larger proportion of their income on essential food items (as shown by the high weight of food in the rural CPI basket).
   • Vicious Cycle: A sudden inflationary shock can push households hovering just above the poverty line back into poverty, eroding their savings and productive assets. This can trap families in a cycle of poverty.
   • Policy Connection: Therefore, controlling inflation is not just a macroeconomic stability objective but also a crucial component of an inclusive growth and poverty alleviation strategy. Government measures like the Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY), which provides free food grains, are essential social safety nets to cushion the poor against food price shocks.