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The Crucial consumer Price Index
Published in Al-Ahram Weekly on 09 - 08 - 2017

The high rate of headline inflation is considered to be one of the main macroeconomic challenges that Egypt currently faces, reaching a maximum of around 30 per cent. Food prices have the largest weight in the average household basket of goods used to calculate the country's Consumer Price Index (CPI), and surges in food prices are recognised to be one of the main driving factors behind high domestic inflation rates, particularly as food consumption has a large imported component as Egypt is a major importer of food items.
In spite of the high rates of headline inflation, however, many people may be suffering from further increases in prices that are greater than those reflected in the announced figures. This has been the case especially after the removal of subsidies on fuel and electricity, in addition to imposing the new value-added tax (VAT) and floating the exchange rate. Yet, accuracy of CPI data is crucial for achieving an accurate measure of headline and core inflation, generated from a basket that provides an accurate representation of typical Egyptian consumer spending.
The CPI is one of the most important statistical and economic indicators as it measures the average change over time in the prices of the goods and services that households purchase every day and thus is used to compile headline inflation rates. The weighting given to items in the basket of goods used corresponds to the relative importance of each item, which equals its share in consumer expenditure measured in terms of the quantities purchased by consumers during the base period of the CPI and prices in the prior month.
As a result, it is essential for the Central Agency for Public Mobilisation and Statistics (CAPMAS), responsible for calculating inflation rates, to evaluate and update the data used for the CPI periodically through revising the basket used to ensure that it reflects current consumer behaviour given possible changes in income structure, demographics, technology, habits and, consequently, spending patterns. Revisions to the CPI basket should include changes in commodity weightings and modifications in definitions as well as the inclusion of a broader range of products and services.
In spite of CAPMAS's efforts towards achieving accuracy, however, the Household Income Expenditures Consumption Surveys (HIECS) for 2010/2011, 2012/2013 and 2014/2015 were not used in compiling headline and core CPI until July 2017, and this may have led to inaccurate measurements due to ignoring changes in the weighting of items in the CPI basket in addition to statistical deficiencies arising during compiling the CPI.
After investigating the latest three series of HIECS (illustrated below), it can be seen that the weightings of the 12 main groups in HIECS 2008-2009 changed compared to HIECS 2014-2015, reflecting changes in the consumption patterns of Egyptian households. Yet, in spite of these changes, the headline and core inflation rates are gauged with reference to the base of HIECS 2008/2009 and a base year of 2010.
Source: CAPMAS (2015) & HIECS
The gap is still wide between public perceptions of inflation and the official figures. In addition, there are drawbacks in the way the CPI is calculated, which in turn negatively affect its accuracy and reliability. For instance, there is the way the outlet sample is selected, since as the selection criteria have never been announced or assessed, suspicion lies over them. Despite assigning a reasonable weighting for rent in the CPI basket, changes in housing prices indicated by the housing price index are also too small compared to reality.
Missing items, quality adjustments and new product biases and administered and regulated prices constitute 18.66 per cent of the CPI basket based on HIECS 2008/2009, and these are also heavily influenced by government policies (ie price or quantity controls and subsidies) rather than being set by the market. The sectors covered include energy-related items and other utilities (ie fuel and electricity, water and sewerage), public transportation, rent and public services (ie education and postal services).
As is suggested by reference to different international experiences, such prices may lead to sharp fluctuations in the CPI if sudden changes occur. For example, the removal of subsidies results in large fiscal impacts and thus a sharp increase in CPI inflation.
Assessing the relative importance of headline and core CPI items is essential for analysing economic and social implications. The weights of certain items may not reflect their actual relative importance for consumers, especially regarding household consumption. For instance, the weighting given to education, healthcare and transport services in the CPI basket do not represent their real importance to households. Hence, there is a gap between the published inflation rates and prices in the market, for example for private lessons (costing more for high school than primary school in urban areas), private health clinics, public transportation, medical services, social insurance, housing rent and subsidies on goods and services that when removed affect prices in other sectors.
The prices of water, electricity and energy affect headline CPI inflation, and they are considered to be critical components of the CPI basket due to their reflecting the actual consumption of households and constituting high shares of consumption.
The importance of the CPI has increased since the CBE announced plans to move Egypt's monetary policy towards inflation-targeting in 2005. Therefore, the assessment of how well inflation is measured in Egypt focuses on how accurately the CPI reflects the actual changes in the general level of prices in the economy. Its importance stems from its various uses and its scope, as well as from its ability to measure inflation's causes and effects and regional disparities in price movements.
As a result, updating CPI data on a regular basis is essential in order to achieve accurate measurements of inflation rates. This regular updating should include updating the base year, as the most recent base year used reflects the accuracy of the index in expressing the real effects of prices, and it is preferable that the base year is for the same reference period, updating the weighting of the index extracted from the search results of the HIECS, and updating the goods and services selected so that they are more representative of consumer preferences.
Lowering the country's inflation rate is also a priority, and thus the Central Bank of Egypt (CBE) should tighten monetary policy. Implementing fiscal consolidation will assist in decreasing inflation by containing domestic monetary conditions. A strong, independent and tight monetary policy is the basis for stabilising or lowering inflation, critical for supporting competitiveness and fostering economic growth in order to help align Egypt with its trading partners.
However, market demand and the new VAT will continue to put upward pressure on prices and may require further increases in interest rates to avoid inflationary pressures becoming more generalised and contain second-round effects.
The writer is a researcher and coordinator of international relations at the Faculty of Economics and Political Science, Cairo University.

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