Improving the price indices

There has been an upsurge in the rate of inflation to almost a double-digit rate and some controversy over the measurement in the case of gas and electricity prices, in the presence of progressive tariffs. This has motivated the Ministry of Planning, the mother Ministry of the Pakistan Bureau of Statistics (PBS), to announce reforms in the construction of price indices.
These reforms include, first, updating the base year of the price indices from 2007-08 to 2015-16. Since the 1990-91, there have been three times when the base year has been changed from 1980-81 to 1990-91 then to 2000-01 and subsequently to 2007-08. There is a perception that the PPP Government changed the base year from 2000-01 to 2007-08 somewhat prematurely so as to bring down the reported rate of inflation. Hopefully, this is not the motivation this time.
The second step forward is to have separate consumer price indices for urban and rural areas respectively. The Sensitive Price Index (SPI) and the Wholesale Price Index (WPI) will continue to be published by PBS on a weekly and monthly basis respectively.
The objective of this article is to assess the potential value of the steps proposed for improving the price indices and the problems that may be encountered. The first step is the change in the base year. Usually, the change is over a ten year period. Therefore, ideally the base year should have been changed from 2007-08 to 2017-18. However, this was not possible because the weights of different goods and services are taken for both the Consumer Price Index (CPI) and the SPI from the Household Integrated Economic Surveys (HIES), carried out periodically by the PBS. The last such survey was in 2015-16. This has meant that the base year could only be extended to 2015-16. Ideally, a HIES should have been completed for 2017-18 before a decision to change the base year was taken.
The disaggregation of the CPI into separate indices for rural and urban areas is an appropriate step. Not only are consumption patterns very different but the path followed, especially of perishable food items, may also diverge. However, there is a need for even more price indices to facilitate proper policy decisions. India has a CPI for industrial workers. This is essential if there is to be a proper upward revision in the minimum wage to keep its real level at least unchanged. Also, India has the CPI at the State level. Similarly, Provincial CPIs will also need to be developed in Pakistan.
There are also a number of technical problems in the construction of the price indices. The most commonly used index is the CPI, which is the measure of 'headline' inflation. Currently, the price index covers 487 goods and services, grouped into twelve categories. Price information is collected from 76 markets in 40 cities.
There are two problems with the CPI. First, the variation in the size of the population of different cities and towns is not properly reflected in the construction of the average price of an item. There are, no doubt, more markets surveyed in the larger cities. However, currently the share in number of markets covered is 29 percent in the case of the three Metropolitan cities -Karachi, Lahore and Faisalabad - combined. However, their share in urban population of Pakistan is 39 percent. As such, the coverage of markets will have to be changed to more accurately reflect the national distribution of the urban population.
Second, the issue is which prices will be used for construction of the rural CPI. Is the intention to directly obtain prices from rural markets, wherever they exist? Alternatively, is the intention to use price information from towns at the rural-urban periphery where purchases are made by rural households of various goods and services? Examples of such locations include towns in Sindh like Mithi, Dadu and Mirpurkhas.
Most countries have also had serious problems in constructing a housing rent index. This is the largest item in the consumption basket with a weight of almost 22 percent in the CPI. The problem is that housing has different characteristics by size, quality and location. Which 'representative' bundles of housing are to be used? There is need for a much clearer methodological statement on the construction of the rent price index by the PBS. Currently, it is somewhat surprising that despite a large and growing housing shortage in the country the rise in rents is reported as even less than the overall rate of inflation. Further, rents are also apparently growing at a lower rate than the increase in the construction input prices and wage rates of construction workers. These are some grounds for suspicion that the overall rate of inflation is being understated by consciously underreporting the rise in housing rents.
The CPI is currently given for five income groups. The lowest income group covers households with income below Rs 8,000 per month while the highest income group is of households with income above Rs 35,000 per month. According to the HIES, the average household income has gone up by over 150 percent between 2007-08 and 2015-16. Accordingly, this escalation factor will have to be applied to the income levels in the groups. For example, the income level of the lowest income group will now be up to Rs 20,000.
The SPI is constructed on a weekly basis and is expected to include essential items and goods which are more prone to price fluctuations like perishable food items. Currently, the SPI is based on prices prevailing in 17 cities and includes 53 items, of which 32 are food items.
The problem with both the CPI and SPI relates primarily to the appropriate price to be used for gas and electricity, in the presence of tariffs which rise progressively with consumption. Currently, in the case of the SPI, the lowest tariff is being used of monthly consumption up to 50 kwh. This has remained unchanged since March 2011. Therefore, while this price may be appropriate for the lowest income group it understates the inflation in the overall SPI for all groups combined. A similar problem is observed in the case of gas charges.
Turning to the Wholesale Price Index (WPI) there are also some problems with this index which need to be resolved. This index is sometimes referred to as the 'Producer Price Index'. This is a price index with the coverage of 463 items. Data on prices are collected from wholesale markets in 21 cities.
The basic problem will be the calculation of weights to be used in the construction of WPI with the base year of 2015-16. PBS derived the weights for 2007-08 on the basis of the value of marketed surplus/production plus imports minus exports. The fundamental issue is whether this information will be available in the absence of a rebasing exercise of the wholesale trade sector in the national income accounts.
The last question is what will be the implication of updating the base year from 2007-08 to 2015-16. According to the HIES, the consumption pattern of households on average of food items collectively has declined significantly from over 44 percent in 2007-08 to 38 percent in 2015-16. There has been significantly less inflation in recent years in food prices. As such, a reduction in the weight of food items will imply a higher rate of inflation following the change in base year. The Government must be commended for opting for a more appropriate and accurate measure of inflation even if this means the risk of reporting a higher rate of 'headline' inflation.
Finally, there is a dire need for strengthening the capacity of the PBS for undertaking more surveys and refining and broad basing indicators of economic trends. There is need for appointment urgently of a qualified Chief Statistician. Also, the Statistical Council must be empowered to exercise full autonomy and thereby ensure greater credibility of the government statistics.
(The writer is Professor Emeritus at BNU and former Federal Minister)