Context: With India's GDP increasing from ₹98 lakh crore in FY14 to ₹173.8 lakh crore in FY24, the recovery from the COVID-19 pandemic has been uneven, and comparisons across different periods may be misleading due to significant base effects. In this context, the choice of a base year for measuring economic variables becomes extremely important, as it can introduce biases that distort growth assessments.
Relevance of the Topic: Prelims- Concept of the base year is vital to understand national accounting, indices like GDP, CPI, WPI, and IIP.
Base Year:
- A base year is a reference year used to measure important economic indicators like:
- Gross Domestic Product (GDP)
- Consumer Price Index (CPI)
- Wholesale Price Index (WPI)
- Index of Industrial Production (IIP)
Purpose of Base year:
- Providing a reference point: The base year serves as a fixed reference point to measure changes in economic variables like GDP, IIP or CPI over time. It allows for meaningful comparisons of these indicators across different time periods.
- To differentiate quantity from value: A reference year is necessary to arrive at the right measure of production activities in the economy like GDP by removing the impact of inflation.
- Composition of Indices: Ensures composition of indices like CPI/WPI reflect contemporary consumption patterns.
- Fixing Weightage: The base year is used to fix the relative weights of different goods and services in the calculation of various economic indicators.
- Facilitating International Comparisons: When countries use a common base year, it enables better comparison of economic indicators like GDP and inflation across different economies.
Revision of Base Year:
- The base year is typically updated periodically (E.g., every 5-10 years) to ensure the economic indicators remain representative of the current economic structure and consumption patterns.
- In India, the practice was to revise the base every 5 years, so as to coincide with quinquennial rounds of the NSSO. However, since 2004-05, base year revision has been staggered due to several reasons.
- Post the financial crisis of 2009-10, 2011-12 was chosen as the base year and the updated series was released only in 2015.
Need for Revision of Base Year in India:
- Old basket of Goods: We continue to monitor a basket of goods that includes torches, radios, tape recorders, CDs, DVDs, audio/video cassettes, and trunks, among some 300 other items which no longer reflect the consumption patterns of the public.
- Disproportionate Weights:
- The weightage of food in the CPI basket has decreased from 60.9% (in 1960) to 57.0% (in 1982) and to around 45% (present), consistent with Engel’s Law. This gradual decline indicates that as the economy grows, the proportion of income spent on food decreases. (Engel’s Law suggests that as income rises, the proportion of income spent on food falls, even if the absolute expenditure on food rises.).
- Additionally, inflation data under-represents services in the consumption basket. In production, services are about 55% of the GDP but have no representation in WPI and about 24% in CPI.
Challenges:
- Selecting the Right Reference Year:
- The reference year must be a normal year with no significant volatility in GDP or Inflation and also be devoid of any structural reforms made in the economy like GST etc.
- Keeping a year with too high growth or too low growth may as base year will eventually result in “high base effect” in the following years.
- Lack of relevant Consumer Data: A new nationwide consumer expenditure survey is long overdue. The last two such nationwide sample surveys were carried out in 2011-12 and 2017-18. Unfortunately, the results of the 2017-18 survey were not released on grounds of unexplained “data quality issues”.