Food Inflation Causes & Solutions

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food-inflationThe unseasonal rains that hit during March this year severely impacted around 94 lakh hectares under Rabi cultivation. The result has been most visible in prices of pulses which have shot up in recent  weeks. This has happened because traditional import markets could not make good the loss of domestic production. Further complicating the situation is the third advance estimates of the Ministry of  Agriculture, which has indicated a contraction in foodgrains production by more than 5 per cent in relation to the preceding year’s level. If that was not all, the Indian Met Department predicted that rains could fall short by 12 percent this year.

All these indicate that the recent marginal improvement in the prices of food items could be transitory and the prices of food items may well shoot up again in coming months. This could be one of the reasons why the RBI decided against dropping the interest rates by more than a token 25 basis points during its bimonthly monetary policy review. For a country like India, where almost half of the expenditure of an average household is spent on filling the plate, poor spend about 60 percent, a high food inflation acts as a hidden tax. For the last few years, the double digit food inflation has been the toughest challenge for policymakers. Food inflation has remained elevated through the economic growth cycle, which displays its stickiness. High food
inflation has also translated in high CPI (consumer price index) inflation as the share of food expenditure in total household expenditure is quite high. This has forced the RBI to keep interest rates high. Also, high food inflation has fed into higher wages and higher inflation expectation. In totality, therefore, high food inflation has been a key economic problem for the country. The composition of the food inflation also shows an interesting pattern. The NSSO surveys on consumer expenditure show that
most categories including cereals, pulses, milk, fruits and vegetables, eggs-meat-fi sh (EMF) and sugar suffered from higher levels of average rates of inflation than overall wholesale inflation since the latter half of 2010s till the end of FY 2012-13. Among these, pulses, milk and milk products and EMF had much higher infl ation and had accounted for over 40 percent of the overall food inflation during this period. What this essentially means is that protein based plant and animal foods have become key drivers of food inflation.

What explains high food inflation?

The enormity of the problem can be gauged from the fact that the government has not been able to control it, despite knowing
how politically damaging it could be. Indeed, high infl ation, primarily high food infl ation was a prominent reason for the rout of last government which was seen as having completely failed in containing prices. Surely, the rot must be going very deep in the
economic structure.

inflation-rbi
Inflation in select food segments Source: RBI Research

While most of the blame has gone to the government of the day for not containing prices, and for good reasons, the mechanism
has not been fully appreciated by the public at large. Fluctuating monsoon, inefficient food marketing structure and hoardings
have been known as the most common reasons for high prices of food items and latter two are domain of government action, or
inaction.

India’s food procurement policy is among the most inefficient and is governed by the Agriculture Produce Marketing Committee
(APMC) Act, which forces farmers to sell their produce to licensed middlemen, resulting in an oligopolistic market which allows
for price distortions. Very often, profi t margins have been found to be in excess of 60-65 percent. The situation is especially worse in items with smaller shelf life, such as fruits, green vegetables and meat products. Last year when prices of Potato and Onions hit through the roof, the central government took out these items from APMC Act, but a summary scrapping is required to ensure real prices prevail. But this can be done only by states and the center can only play a persuasive role in it. But a start is desperately needed in this regard to prevent price cartelization.

Supply side constraints As is the case in many underdeveloped countries, supply bottlenecks and supply shocks are crucial features of the Indian food economy. Loss of produce is a direct fallout of supply bottleneck which has not received enough attention in public debates. Wastage due to underdeveloped supply infrastructure, whether it is the lack of storage facilities or transport infrastructure, is over 20 percent. Furthermore, estimates show more than 30 percent leakage in the PDS system. It we take into account, the delay and temporary scarcity that these bottlenecks create on top of decrease in available stock, the impact on prices can be quite drastic.

monsoon-stat
Failed monsoons lead to higher food prices Source: RBI, Indian Met Department

Because of excessive dependency of Indian agriculture on Monsoon, the food production and in turn food infl ation is highly dependent on rainfalls. Years of severe rain defi ciency have invariably been associated with high food prices, high food grain stocks notwithstanding. This was seen very clearly in the years 2002, 2004, 2009 and 2012, which were highly rain deficient and witnessed rising food inflation.

But supply shocks also come in form of structural changes having long term impact. The classic example was witnessed in mid
1990s, when a large number of farmers shifted from growing food crops to commercial crops for export purposes. Such developments result in a permanent reduction in the agricultural produce resulting in higher food prices.

Additionally, the inflation in key inputs such as fertilizers, electricity, diesel and animal feed have all been at elevated levels over the last few years and fed into the price of agro outputs. While fertilizer prices have remained subdued this year, thanks to a decline in crude prices globally, that is not a cause of joy as situation can turn worse as and when crude fl ares up.

Rural wage hike: the real culprit?

Wages are the most important input cost of agricultural production. As such, a higher rural wage is bound to push food inflation higher. According to estimates of the Commission for Agriculture Costs and Prices (CACP) of the Govt. of India, a one percent rise in wage inflation pushes food inflation by 0.3 percent. This was also underscored by a study of renowned economist Ashok Gulati which showed that higher rural wages were second most crucial reason for the food inflation in India during 1995-96 to December, 2012, second only to fiscal deficits. Higher global food inflation was found to be another reason for higher food inflation during this period. Furthermore, an RBI research concluded in 2014 that higher food inflation could be attributed to higher rural real wages which influenced prices in short as well as in the long term. But what led to such hikes in rural wages? There are multiple reasons. The most visible of these is the ill thought out MGNREGA scheme which has distorted wage discovery process by creating  an artificial, high floor price for rural workers. Once set in motion, this high wage reflects in high food prices, which in turn pushes rural wages even higher. Rapidly expanding employment opportunities in non-farm sectors which vied directly with farm sector for rural labor provided additional upward nudge in rural wages since the latter half of the last decade. Construction and manufacturing sectors are typical sectors which weaned away a large number of rural workers from farms. However, as the economy slowed and the RBI curbed money supply over last 2-3 years, the rural wage inflation came down in last two years. The high base effect could also have played some role here.

Higher deficits explain demand pull

Gulati’s study showed that high fiscal deficits have been the most potent culprit in food inflation going out of hand, even more than the rise in rural wages. And there is merit to this assessment. High defi cits have worked in two ways in exacerbating the food prices. First, money spent on schemes like MGNREGA pushed up cost of rural workers; and secondly, it fueled a consumption binge.

In order to fight economic slowdown in 2008, India, like many other countries, offered a fiscal stimulus by running high deficits. But instead of developing return generating economic infrastructure, the stimulus went in directly into the pockets of people in form of  sixth pay commission in urban India and agricultural loan waiver in rural India. This boosted demand across all consumption items and with supply not increasing, prices went up, especially the prices of food items. In short, the large fiscal
deficit that was resorted to boost the economy, ended up doing the opposite as the central bank had to push up interest rates to fend off high inflation.

Taming the beast

What transpires from the above is that the food inflation in the country has been because of a few broad factors, namely inordinately high rural wage increase, supply side inefficiencies, monsoon failures and shifts from food to commercial crops. On top of it all, politically motivated increases in minimum support prices for various crops have played havoc with the food prices. In any industrial good, a rise in wage and input cost may not reflect so much in prices of final good if the productivity also rises
commensurately, but that has not been the case with farming. So, first and foremost, the agricultural productivity needs to rise.
However, that is not a short term prospective and would take a long term planning, incentivization, application of technology and most importantly, financing. In the meanwhile, pronounced efforts are required to address structural and monetary issues.

The most significant aspect of money management for controlling inflation in general is to manage deficits more judiciously. While it is nobody’s case to have high deficits, more crucial is to manage what that deficit is financing. A high deficit which goes directly in fuelling consumption is slated to keep inflation at high pedestal and because the food supply is highly inelastic, it is food inflation which would be more elevated.

As for supply shocks and bottlenecks, they need immediate and comprehensive overhaul. Long term planning needs to address
how nearly half of agricultural land in the country which is unirrigated, can be watered. This is the only way to prevent monsoon failures from periodically flaring up food prices. Secondly, addressing infrastructural problems such as cold storage and efficient
transportation could go a long way in keeping prices of protein based foods and fruits and vegetables in control.

Controlling key input costs is a second area on which concerted work is required. This is easier said than done because not only
relative prices of urea and other fertilizers need attention, but also the targeting of subsidies has to be looked into. Electricity and diesel subsidies to farmers have been more of a political issue so far and the actual impacts of these subsidies on production efficiency and production cost have not been properly assessed. But that is absolutely necessary to better target the subsidy and to fi nd out how to increase the productivity of farming. Two of the most politically sensitive aspects of agricultural produce prices are MSPs and APMC Act. While APMC Act needs to be done away with at earliest, a nuanced approach is require on MSP. Increasing MSP without any increase in agricultural productivity is just a tool to transfer inflation to urban areas that buys food and does not grow any of it. As such, a judicious balancing is required to ensure reasonable compensation to farmers and at the same time, not hurt final buyers.

But over the long term, all these measures could still come undone if the crucial question of raising farm productivity is not addressed. Only when a rising rural wage is accompanied by a commensurate rise in productivity, can final food inflation be contained. The Economic Survey of 2012-13 listed three sources of higher labor productivity; first, more physical capital employed per worker; second, more human capital per worker; and third, greater total factor productivity (TFP). In farming, this means higher productivity could come from greater farm mechanization and by enhancing the quality of farmers through right education. Needless to say, this cannot be done in one year, but an urgent beginning is required.

More than an economic phenomenon, food inflation is a human problem, because it hurts poor the most, who spend more than half of their entire earning just to fill their plates. For far too long, political expediency and structural inefficiencies have enriched a few at the expense of all, but as a country and more so, as a society, we need to ask ourselves how long can we continue with this inhuman torture.

It’s time government wakes up and do what is needed to preserve the life and health of its citizens, or else, all its grand plans would wilt under the weight of an unhealthy population who could not buy nutrient food.