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Tue, 21 October 2014 12:42:42
Sri Lanka inflation index controversy takes new turn
12 Dec, 2007 10:20:58
Dec 12, 2007 (LBO) – A controversial new inflation index that claims to show lower inflation in Sri Lanka has completely dropped alcohol and tobacco from its market basket, an official statement has revealed.
An official statement from the Central Bank's statistics department said the existing Colombo Consumer Price Index (CCPI) does not accurately represent modern consumption behaviour since it was based on consumption habits of working class families in 1951.

"The weight structure of the CCPI was not revised to capture the changing consumer habits," the Central Bank said, though the Census and Statistics Department said it had been revised several times.

Right and Wrong

The release of the new CCPI(N) index comes while the existing index for consumer prices in Colombo showed 19.6 percent inflation. The new index showed inflation at 19.3 percent in November and sharply lower inflation at other times.

But an island-wide index constructed less than a decade ago showed even higher inflation of 22.1 percent in September making nonsense of official claims that the inflation showed by the existing Colombo Consumer Price Index was 'wrong'.

The index has higher weights for telecommunications, water, electricity, gas, health, transport, household goods, which have become important expenditure items of people.

The index has also dropped kerosene, which as a price-controlled item tended to understate inflation until the government allowed price adjustments, causing index movements to be jerky.

But the new CCPI(N) index has come under fire for being unsuitable to index wages of mostly blue collar workers, as it has a consumption basket claiming to represent 'all' households in Colombo.

In Sri Lanka less than 80 percent of the households have electricity, and even lower amounts pipe-borne water supply, except in Colombo.

Colombo is an area which contains most of the millionaires of the island, and has the least poverty. High income classes spend less on food as a proportion of their income than poor people.

Food prices are usually the first to respond to money printing. In the CCPI(N) index the weight of food had fallen from 68.3 percent to 46.7 percent.

A working class expenditure pattern is needed to index wages as they are the most hurt from money printing. In the United States, CPI-W which measures the bottom 32 percent of urban households is used to index wages.

Central Banking

Sri Lanka's central bank has come under heavy fire for printing money willy-nilly and impoverishing poor people further through high monetary inflation since it was created in 1951 with money printing powers, after the country scrapped a currency board system.

Between May and September 2007 the Central Bank printed 45.2 billion rupees to bridge a budget deficit sending inflation rocketing up and the rupee plunging down.

In the past during incidences of heavy money printing, food items have been the first to be put under government price controls, giving rise to shortages and black markets.

The CCPI(N) index has been labeled by critics as an attempt by authorities to understate inflation and give themselves more room to print money.

Earlier this year Argentina's president sacked Graciela Bevacqua, the top statistician in charge of inflation reporting, after she allegedly refused to change the index weights amidst high inflation.

Argentina had also banned beef exports in a bid to keep prices low and imposed price controls. Sri Lanka has now banned the export of coconuts, though only a few items are under price control.

Critics say manipulating inflation indices to understate inflation is a common tactic in many countries with central banking regimes, including the United States.

However when authorities go too far in manipulating inflation indices it causes frequent asset price bubbles and more economic instability, while the exchange rate also weakens against countries that pursue tighter monetary policy.

Contradictions

While claiming to represent spending habits of modern consumers more accurately through a newer income survey, authorities contradicted themselves by dropping alcohol and tobacco from the CCPI(N) index altogether.

"This category had a weight of around 1.8 per cent in the 2002 survey," the Central Bank said.

"However, it was excluded from the CCPI(N) due to the fact that those items are subject to heavy taxation to discourage consumption. Inclusion of items with such heavy taxation distorts the resulting measure of consumer inflation."

Economic analysts say in many countries statisticians adjust reported data on alcohol and tobacco consumption in household income surveys as it had been found that respondents to surveys frequently under-report alcohol and tobacco consumption.

In addition to underpaying workers, an index that understates inflation would allow authorities to overstate economic growth numbers, pay less interest on inflation linked bonds, and collect more seigniorage revenues.

There have been mounting calls for legislated inflation targeting in Sri Lanka to limit money printing by giving the Central Bank a parliament mandated target of less than five percent a year.

Others have also called for the abolition of the Central Bank altogether and a return to a pre-1951 currency board arrangement.

Singapore deliberately kept its currency board arrangement after independence saying that using central bank credit to bridge budget deficits or printing money "was an invitation to disaster".
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READER COMMENT(S)
2. Dec 12
What's all this fuss about a 0.3 difference in the earlier CCPI & CCPI(n)? what is more important is that both measures have registered a near 19% inflation.
1. Grateful Dead Dec 12
It would be an ok move to exclude these two from an SLCPI (not many women and children drink and smoke outside Colombo i feel). If you added kasippu instead it might show a fairer picture.

However, i disagree with the point made about excluding items that are heavily taxed - coz the consumer is faced with the high price due to tax, so why isn't that counted as inflation??