Colombo COL index outdated

Dr. P. N. Weerasinghe, Director Economic Research of the Central Bank, responded to questions from the newspaper on the cost of living index:

What is the consumer price index
used in Sri Lanka currently?
In Sri Lanka, the Colombo Consumers’ Price Index (CCPI), which is compiled and published by the Department of Census and Statistics (DCS), is considered the official indicator of changes in cost of living and used to determine the cost of living allowances payable to government servants, plantation workers and workers in other industries covered by the said legislation. It is widely used by firms and individuals in planning current and future consumption and investment, thereby affecting inflation expectations.

How accurately does it reflect the
cost of living?
The CCPI is based on the spending patterns of the lowest 40 per cent of households, who lived in the Colombo Municipal area in 1949/50, by their monthly expenditure. Therefore, it is not an accurate measure of cost of living in Sri Lanka in the current context.
However, now it doesn’t even reflect the cost of living of the people living in Colombo Municipal area. This is because the original weights of a price index for different items automatically changes over time. The shares of the items with rapid price increases in the index rise while the shares of items with lower price increases attenuate. As an example, the original weights of kerosene and vegetables in 1952 have been 1.1% and 5.9%. Now kerosene has a share of around 6% and vegetables has a share over 21%. At the same time, the share of clothing category has dropped from 9.4% to 1.9%.

What does that mean?
If the prices of vegetables increase by 10% due to a landslide in Nuwara Eliya, CCPI increases by 2%. If the kerosene prices are increased by 15%, it increases by another 1%. But, if the prices of clothing decrease by 10%, due to increased production, inflation will go down only by less than 0.2%. When this happens continuously, the inflation is overstated as the share of items with rapid price rises, increases.
This is only a part of the problem with the index. The consumption patterns do not remain unchanged. When the income level of people increases the share that they spend for food usually decreases.
When the infrastructure facilities develop, people reduce kerosene usage and consume more electricity. In 1953, only 4.3% of the households had electricity but by 2003 this has increased to 75%. In the Western Province this ratio is 94%.
The weight for kerosene in the index should represent this. But, what has actually happened? The share in fact has increased. The CCPI was originally designed as a measure of the cost of living of low-income households then lived in Colombo Municipal Area, but not as a measure of inflation in Sri Lanka. But, as explained above, now the CCPI does not even represent the current expenditure patterns of that selected segment. At least it doesn’t represent the expenditure pattern of the original sample prevailed in 1952. That’s why we say the CCPI is “disreputably outdated”.

Yes, the annual report of the Central Bank called the CCPI “disreputably outdated”, yet it is still being used. Why is this?
As explained earlier, the CCPI is highly outdated and it has been outdated for decades. The Central Bank, as one of the major users of the index has highlighted this issue since 1970s. Consequently, the Sri Lanka Consumers’ Price Index (SLCPI) was introduced in 1997. Unlike the CCPI, SLCPI has an island wide coverage and represents the consumption patterns of 80% of the population.
However, this index has also not been revised since then and becomes outdated now. As an example, SLCPI also over represents food category. Another major problem is that the one-month lag involved in releasing SLCPI numbers. This in fact is a tradeoff for it’s comparatively larger geographical coverage. However, as a result many people make judgments based on the movement of CCPI, rather than waiting one more month until the release of the SLCPI.
Anyway, the Central Bank, like any other central bank in the world, clearly knows the difference between the inflation and the cost of living. We also can estimate the extent to which a particular price index can represent even the cost of living.
Therefore, when we take our policy decisions we rely on our analysis of the movements of various price indices, internally derived core inflation measures and even internally computed cost of living indexes.
But, whatever the actual inflation in the economy, many people are still relying on the CCPI. Many people who never consume kerosene negotiate for pay hikes when the CCPI moves up just due to the increase in kerosene prices. Many investors, fund managers and bankers take serious business decisions only looking at the impact of price increases on the cost of living of 415 households lived two generations ago.
Therefore, the changes in CCPI make a real economic impact on the economy through expectations. On those grounds, the Central Bank also has to consider the movement of the CCPI to a certain extent when policy decisions are taken.

Will there be any revisions to the CCPI? If so, what will those changes be?
The problems with the CCPI were extensively discussed at the National Economic Council meetings since the beginning of the year. The Department of Census and Statistics is planning to introduce a new representative price index during the year in place of the prevailing official price index.

Do you think those changes will make a real difference to the people at the ground level of the Sri Lankan economy?
A revision of the price index will help economic decision-making by major stakeholders of the economy and it will eliminate some of the existing anomalies. However, the people at the ground level of the economy will only have a neutral impact by revising the price index. Their living conditions can only be improved through long-term sustainable economic growth and elimination of disparities.

What/Who are the obstacles/opponents you are likely to confront when effecting these changes?
The revision of the index is a technical process usually done very frequently in many countries.
However, since we have not revised the index for decades, and we are so used to CCPI numbers, many financial decisions and medium-term contracts in the county have been based on the CCPI. Therefore, one might have a wage contract that says ‘an allowance of Rs. 5 will be paid for an increase in each index point of CCPI’ or a supplier contract that reads, as ‘The price paid per unit of X will be revised according to the increase in CCPI’. Such contracts, if any, may have to be renegotiated if the index is revised. Other than that there will not be any obstacle when revising these changes.

What is the significance of the SLCPI (an index issued by the Census Office) to the Central Bank and the government?
As explained earlier, the SLCPI is more representative of actual changes in cost of living of an average Sri Lankan, when compared with the CCPI. However, SLCPI too does not represent present consumption patterns precisely. The government as well as the Central Bank carefully observes the movements of SLCPI also as an alternative proxy of inflation.

The CCPI is being used by the Central Bank and the government to calculate the cost of living and the rate of inflation, yet the government is using the SLCPI to determine monetary policy. Why is this?
It is a misconception that the government and the Central Bank are using SLCPI to determine the monetary policy. The SLCPI, similar to the CCPI is a measure of cost of living. They represent the changes in consumption expenditure of a particular segment of the economy.
Therefore, central banks usually consider that the changes in a cost of living index are less important to the monetary policy than a correct measure of demand pressures in the economy.