Rate Cut, Inflation and the Curious Case of CPI Index

Dr Raghuram Rajan finally chose not to renew his term with RBI. The news of his departure has re-ignited the debate on interest rates, inflation and overall growth. Though the regime of Dr Rajan did see a reduction of 1.5% in the interest rates over last three years, but his grim outlook on the overall growth and inflation made banks keep the interest rates high.

From the time Dr Rajan took over, the inflation rate indeed came down from double digits to below 5%, though it is debatable if the drop in inflation was due to monetary policy or due to massive drop in crude oil and commodities prices. Unfortunately, in India, the discussion on inflation always hovers around food inflation due to high weightage given to food items (50%) compared to, say, housing where, on an average, an urban household spends almost 30% of income on rent/EMI while housing weightage is just 9%.

A cursory glance on CPI construct throws some interesting data. Weightage of housing in inflation index is 9.7%, education is 3.3% and medical care is a mere 5.6%, while weightage of food is around 50% (egg and fish ~ 2.89%, and paan/tobacco ~ 2.13%). So if one goes by CPI nos, it would seem that an average household spends almost two times the money on milk (7.7% weightage) than on education (3.3%) and healthcare (5.9%).

Needless to say that a 300% jump in onion price creates massive impact on inflation while 10% yearly increase on housing (in case of rent) does not create any impact (0.9%).

The defenders of CPI index may argue that this data is built around urban poor, and hence, does not necessarily match with consumption patterns of normal middle class. But even then, the ratios are highly suspect where it seems that urban poor are guzzling milk (7.7% of income) and are least sensitive to education (3.3%)!

However, given such CPI construct, policy-makers get a myopic view, and start chasing food inflation in order to remain media-friendly while an average household continues spending maximum money on housing (EMI/rent), medical care (cost has jumped almost 10x in last 10 years) and education (cost jumped by more than 10x in last 15 years), which is quite paradoxical as our policy makers / leaders never tire of reminding us of the socialist status of our country where average household is spending maximum on Housing, Education and Healthcare (sectors ideally looked after by State).

This war on inflation, or rather war on food inflation, has created a complicated scenario where to keep 30% of population (urban population) virtually happy, 70% of the population (rural population) pays a huge price in terms of forced poverty on account of low food prices. The cost of every item, be it education, health or fertilizer has jumped many times but prices of vegetables/commodities, etc., in times of glut still remain at 1990 level (unfortunately, glut scenario happens almost every alternate year).

Unfortunately, Indian policy makers remain more focused on plight of urban poor than that of rural poor, an outlook that in 1943 resulted in Bengal famine – a man-made holocaust.

This lack of understanding of agriculture prices and focus on keeping food inflation, etc., has resulted in scenarios where Indian framers have stopped producing many grains / pulses, etc.

Given the apathy of State towards farmers / rural poor, its not far off when ongoing climate changes will force India back to the brink of agricultural crisis of pre-independence era.

Hence, it is high time that rather than chasing wrong goals, mandarins at RBI / Finance Ministry take a hard look at the data and chase the inflation that matters rather than being media savvy.

Till it is done, housing, education and healthcare sectors will continue to bleed average middle class while focus on food inflation will continue to force farmers to commit suicide and live in perpetual poverty. 

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You may also like the following articles:

Raghuram Rajan Controversy: Why Subramanian Swamy HAS a Point. An article on Dr. Raghram Rajan issue that recently stirred the media.

2014: Economic Crisis at the Gate. This article, published in Jan 2014, argued that India will face lack of growth and economic crisis despite best intentions of upcoming new Govt, and the usual monetary economics tools of interest rate / inflation wont work.