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The availability of year-on-year headline CPI inflation data from January 2012 has attracted the attention of market participants, analysts and policymakers. For the first time, a composite retail price index, with rural-urban disaggregate sub-components, is published at a fortnight’s lag. The new series is intended to overcome deficiencies in India’s price statistics, viz lack of a comprehensive retail price indicator; existing indices were sector-specific (e.g. CPI, Industrial workers or CPI(IW), CPI-Agricultural Labourers, or CPI(AL), with different index baskets. Such issues obstructed finer monetary policy decisions, leaving the wholesale price index (WPI) as the headline inflation indicator.
Specifically, the increasing divergence in WPI-CPI inflation rates has prompted the RBI to attach more significance to the latter in monetary policy formulation. While the central bank continues to anchor inflationary expectations to WPI inflation, its policy rate has increasingly tracked core CPI . Analysts believe that the new CPI is currently in a transition phase and it’s only a matter of time before the RBI formally switches to it as inflation anchor.
Notwithstanding the inherent appeal in targeting retail price inflation for monetary policy purposes, should the new index be taken at face value, presuming the data series are robust? Statisticians would surely caution against any hurry with advice to wait until the series is long enough and stabilised. But given the appeal, few would like to wait.
Therefore, an alternative approach to test out the new index is to examine its rural-urban components and see if initial price trends conform to common priors about price formation in both segments. The twenty data points available so far, although not long enough for reliable statistical scrutiny, provide early indications on evolving inflation trends. These raise a few questions, and some disquiet, as to how robust the index might be.
The first of the accompanying charts shows an initial gap of 1.8 points between rural and urban retail inflation, which disappears with the two series converging by July 2012. As a crude counterfactual, the other chart plots CPI (IW) and CPI (AL), despite the limitations for comparison with the new CPI index. The old CPI rural-urban inflation rates exhibit a measure of divergence—inflation for industrial workers stayed above inflation for agricultural labourers broadly until September 2012, the trend reversing thereafter.
So, why should rural and urban inflation rates converge as per the new CPI? That’s puzzling, given that the sub-components of each sector carry different