The CPI unexpectedly and mysteriously clocked in at 7 percent in October 2018. The consensus estimate was 5.6 percent. It is not the analysts who read it wrong. It is perhaps the PBS in its methodology that got it way off.

The CPI on monthly basis increased by 2.6 percent in October 2018 to substantially increase the base, the adverse impact of which, would remain visible for 12 months. The biggest increase was recorded in gas prices at a whopping 105 percent. With its weight of 1.57 percent in CPI, the gas prices increase single handedly contributed 1.65 percent to monthly inflation increase in October - almost two third of CPI hike.
Recall that the government increased gas prices ranging from 10 percent to 143 percent on varying slabs. For domestic consumers having an average monthly bill under Rs2,618 (inclusive of GST), price was increased by 10 or 15 percent.

Considering low gas usage in summer, majority of households fall in this category. This implies the gas price increase in CPI should have been between 10-15 percent - SPI recorded it at 11.5 percent.

There is no way to rationalize average household gas price increase at 105 percent. This implies that the top two slabs where the average monthly bill were north of Rs15,000 have the highest weight in computing the CPI. On the flip, their share in gas consumers is a mere 5 percent. The computation is simply flawed and does not reflect actual inflation.

The comedy of errors may not end here. The electricity tariffs revision is to hit inflation soon where the decision is of no change for 70 percent of domestic consumers, while the tariffs have increased by 10-15 percent for the rest. With a weight of 4.4 percent, should the PBS use the top slab as base, its impact on CPI would be 0.7 percent.

The CPI base is already artificially inflated by unusual increase of house rent index since April 18 - it was increased by 3.1 percent in April to change the base of CPI up. There are flaws here too - the house rent index is computed from a survey of 17 cities. The computation is simple average increase in all the cities, rather than having weights based on population. Lately, the increase in smaller cities is higher than big urban centers. For details read "inflation to say in single digit' published on 18th October 2018.

The Finance Minister needs to take notice of these abnormalities in CPI methodology. Its adverse impact is compounded. Higher record of CPI dilutes the impact of currency depreciation on real effective exchange rate, implying more room in depreciation to bring REER in equilibrium. This builds higher expectation of inflation which in economics is a self fulfilling prophecy.

The CPI after the gas price computation blunder is expected to average around 8.5-9 percent for FY19 with second half in double digits. Unless, of course, the PBS comes up with a correction. There is no way that the October’s numbers represent the true picture.