Measuring CPI Impact of Free Foodgrain Distribution

Source: The post Measuring CPI Impact of Free Foodgrain Distribution has been created, based on the article “Welfare programmes impact the retail prices relevant to people” published in “Live mint” on 7th January 2025

UPSC Syllabus Topic: GS Paper3- Issues related to direct and indirect farm subsidies and minimum support prices; Public Distribution System- objectives, functioning, limitations, revamping

Context: The article discusses a MoSPI discussion paper on accounting for free foodgrain distribution under the Public Distribution System (PDS) in India’s Consumer Price Index (CPI). It addresses challenges in incorporating free items in current and future inflation measurements. Measuring CPI Impact of Free Foodgrain Distribution

For detailed information on Consumer Price Index (CPI) read this article here

What Challenges Are Faced in Measuring CPI with Free Foodgrain Distribution?

1. Impact on CPI Weight: Free wheat and rice, which have a combined 7.5% weight in the all-India CPI, create challenges in adjusting price calculations when their cost drops to zero.
2. Incorrect Redistribution: Redistributing the weight of free items only within the same category is flawed. For example, households receiving free rice may spend extra income on other goods, not just cereals.
3. Transparency Issues: The absence of parallel indices (with and without the changes) for at least one year creates doubts about CPI accuracy.
4. Policy Impact: Opaqueness in adjustments fuels speculation about inflation data and its role in policymaking.

For detailed information on Reassessing Inflation Measurement read this article here

How Does Free Foodgrain Distribution Affect Household Income and Spending?

1. Free foodgrain distribution increases disposable income by eliminating costs for essential items like wheat and rice.
2. Around 800 million households benefit under the National Food Security Act.The savings are likely spent across the entire consumption basket, not just on food items. For example, households receiving free rice are unlikely to spend all savings on cereals alone.
3. Redistribution of item weights in CPI must reflect this behavior.
4. Transparent CPI adjustments can improve the accuracy of economic measures and policy decisions.

What is the Proposed Solution for Transparent CPI Measurement?

1. Dual Index Production: Produce two versions of the CPI, one reflecting the impact of free food distribution and one without it.
2. Duration for Comparison: Continue this dual index production for at least one year.
3. Purpose: This approach allows users to compare and understand the impact of including free foodgrain distribution on inflation measurement.
4. Transparency and Trust: Publishing both indices enhances transparency and builds trust in government statistics, addressing concerns about the accuracy of inflation data.

Why is Regular Household Consumption Survey Important?

1. Accurate Weighting in CPI: Regular surveys ensure the CPI reflects current consumption patterns, especially when free distribution of items like wheat and rice alters spending habits.
2. Dynamic Index: A dynamic CPI index with updated weights captures changes like free foodgrain schemes, impacting 800 million households.
3. Transparent Adjustments: Transparent methodologies prevent speculation and doubts, enhancing trust in government statistics.
4. Policy Effectiveness: Accurate data aids inflation targeting and welfare programs, especially if items like pulses and edible oils are included in schemes.
5. Black Swan Events: Regular updates help address crises like COVID-19 effectively.

Question for practice:

Examine the impact of free foodgrain distribution on household income, spending patterns, and its implications for Consumer Price Index (CPI) measurement.