Changes in the new CPI series aim to provide a more accurate reflection of the cost of living in Nepal, influencing how inflation is measured and interpreted
The Nepal Rastra Bank (NRB) recently updated the National Consumer Price Index (CPI) used to calculate headline inflation in Nepal. This update involved rebasing the CPI from 2014-15 to 2023-24, which marks the sixth update since the NRB began compiling the CPI in 1973-74. The revision takes into account significant shifts in households' spending and consumption patterns.
Inflation is a major macroeconomic indicator, yet it is also one of the least understood. There is often a common complaint that the inflation figure reported by the NRB underestimates the actual increase in the cost of living. Coming up with a single magical figure that represents the average price change of the myriad goods and services consumed or expended by households seems implausible. Still, all countries calculate this figure, and an increasing number of central banks are mandated to maintain inflation within a specific range, often referred to as inflation targeting regime.
One of the most common measures to compute inflation is the CPI. While the history of the compilation of the CPI dates back over a 100 years, it gained prominence during World War I for wage negotiations. Even today, several countries produce different versions of CPI for specific sections of the population. For example, India has different CPIs for industrial workers, rural labour and agricultural labour, apart from the national level.
The calculation of the CPI involves several steps. First, goods and services are selected to be included in the CPI basket based on large-scale household consumption and expenditure surveys. These items are then assigned weights based on their ratio of expenditures to the total expenditure and consumption. Then the market centres and outlets are chosen for price collection while specifying the brand or characteristics of these goods or services. Prices are then collected at regular intervals from these centres and outlets to estimate the pure price change. The CPI is generally calculated in two stages. The first stage, known as the elementary aggregate indices, is the basic building block and is often unweighted. The second stage consists of the higher-level indices, which are calculated as weighted averages using the expenditure shares of households as weights, of the elementary aggregate indices.
The NRB published the first CPI in 1973-74 based on the Household Budget Survey in 1972-73. Since then, the NRB has periodically conducted five surveys to revise the basket and weights to account for the shift in household spending and consumption patterns. However, in the current revision, the basket and the weight used for the CPI calculation were obtained from the Nepal Living Standard Survey IV (NLSS-IV) conducted by the National Statistics Office (NSO), as it contains detailed information on household expenditure and consumption of food, non-food and services from a nationally representative sample of 9,600 households across the 15 analytical domains (seven provinces with rural and urban areas and the Kathmandu Valley).
The NRB conducted additional market surveys to identify the items included in the categories of health, education, clothing, footwear and some food items not explicitly mentioned in the NLSS-IV. A separate survey was carried out to determine the outlets for regular price collection. Compared to the previous CPI, the new series has made several improvements - it includes a basket of 525 items, up from 496 items; prices are now collected from 87 market centres in all 77 districts, an increase from the previous 60 market centres in 50 districts; provincial CPI is now computed for each of the seven provinces, among others.
The NRB recently released the new CPI series in its regular monthly publication on the current macroeconomic and financial situation for the first month of 2024-25. The average inflation in the first month came in at 4.1 per cent, with Food and Beverage inflation at 6.17 per cent and Non-food and Service inflation at 2.94 per cent. The overall inflation figure often masks the variation in inflation in the sub-categories. For example, the inflation for the Vegetable group soared to 19.07 per cent, and the Pulses and Legumes increased by 12.09 per cent. Disparities in inflation can also be observed at the provincial level. Thus, the overall inflation figure may not match the increased cost faced by households. Moreover, each person has an 'individual inflation' rate depending on the goods and services they consume. For a vegetarian, an increase in the prices of meat does not impact the cost of living.
A more subtle point is that the term 'fixed basket' refers to all 525 items included in the CPI, but a person's consumption basket varies. People often substitute among different items due to changes in income or in relative prices, and preferences and quantities of goods and services consumed do not remain same. To accurately capture the cost of living, prices should be compared to maintain the same level of utility or standard of living, but this is difficult to implement in practice due to the substitution effect.
To conclude, the changes in the new CPI series aim to provide a more accurate reflection of the cost of living in Nepal. These changes will influence how inflation is measured and interpreted. The basket and weights are derived from the NLSS-IV, which offers several benefits such as avoiding resource duplication, maintaining consistency of household expenditure data, and utilising the robust Living Standard Measurement Survey methodology. Additionally, these changes pave the way to assign the responsibility of CPI computation to the NSO or other relevant agency to avoid the perceived conflict of interest of the NRB, which has the mandate to maintain price stability.
Panta is the director of Price Division at Economic Research Department, NRB
