By Nidhi Mardi

Edited by Liz Maria Kuriakose, Associate Editor, The Indian Economist

Inflation shot to a five month high as speculation began for a high food inflation in early June, bringing back the prospects of ‘onion price scare’ to the Indian economy.  As Iraq crisis threatens to spur global oil and food prices,  the Modi Government reacted by setting a minimum export price for onions of Rs 18000 per ton to discourage overseas shipments amid an inflation scare that threatens to stroke public anger over rising prices at local food markets.  While many empathize with Jaitley, that food inflation is primarily going to play a spoilsport to his plans to revive growth, he is all set to target and crack down speculative hoarding.  The rain gods doesn’t seem to be in Mr. Jaitley’s favor either, where forecasts of 2014 being an El Nino year led India Meteorological Department officials to speculate weak monsoons, with simultaneous impact on agricultural output and food inflation.  While RBI Governor Raghuram Rajan feels that the Indian economy is well prepared on its external front to combat inflation, many economists predict that simmering under the sea of apparent calm of sufficient reserves and a low Current Account Deficit, is a burning cauldron of speculated high food prices which will burst and skyrocket food inflation anytime in the near future.  However we need to realize that food inflation is an evil embedded deeply in the Indian economy and has more factors affecting it than the mere prospect of weak monsoons.

One can clearly note that though deficient monsoons were experienced in the periods 2002-03 and 2004-05, yet food inflation remained largely constant and even declined to 3.8% during the same. The problem of food inflation is the fruit of the 2010 droughts and the aftermath of the 2008 Global financial meltdown. Thus, though the recent years have seen good rainfall, food inflation has increased by more than 10.3% suggesting that there are more factors in play here.  Some economists believe that in the past decade due to rise in income levels, the share of income spent on food has fallen. However at the same time, there has been an increase in real expenditure on protein foods and vegetables across income stratas in rural as well as urban areas. Thus, this increase in demand has led to greater allocation of spending on cereals to other food items like protein foods and vegetables, thereby driving up the prices.  Secondly, the spurt in prices of inputs such as fuels and fertilizers can be viewed as a fruit of the Global Financial meltdown combined with high international oil prices and exchange rate depreciation. This is one of the reasons why the Iraq crisis is feared by Indian economists. Another reason for the persistently high inflation can be the sustained increase in agricultural as well as non-agricultural wages. A possible explanation for this is the socially inclusive policy MNREGA which has set a floor price for rural wages and thereby increased the bargaining power of the work force. This persistent increase in rural wages with a decelerating GDP growth is believed to have overshot economic growth cycle.

Raghuram Rajan hopes that food prices would come down with appropriate food management by the government and RBI plans to keep a vigilant eye on food inflation. It is important to realize that a supply shock of this magnitude requires the policy to respond to it suitably.  We, in India constantly witness a supply shock induced inflation which is medium term, primarily due to high inflation expectations in the economy. It is argued that if inflation expectations are low and well anchored, the inflationary impact of supply shock is short term and temporary.  However inflation expectations are hard to gauge in an economy like ours. However measures like RBI’s quarterly household inflation expectations surveys indicate that inflation expectations have been elevated in India in the past few years to double digit figures. Thus, in this scenario it is evident that though the direct role of monetary policy to combat inflation is limited, yet monetary action in a way helps to anchor inflation expectations.

Thus to deal with the scenario of persistent food inflation, coupled with the speculation of weak monsoons and the Iraq Crisis, Mr. Jaitley’s Finance Ministry has to look beyond the budget to effectively fulfill its agenda.  As pointed out by Shri Deepak Mohanty, Executive Director, RBI the first and foremost step should be to curb agricultural wastage by strengthening supply chain logistics and setting up cold chains and processing facility at production areas. Secondly, there is need to augment productivity in a non inflationary manner through mechanization. The main hurdle in this agenda is that the size of landholding is small so this puts a constraint on the choice of mechanization.  Contract farming and leasing of farmland is a way out of this dilemma. There is also a need to liberalize agricultural trade and effectively modify APMC and exempting perishables like fruits and vegetables from the provisions of APMC leading to better price discovery. The newly elected NDA government is believed to be in a mood to do the same. There is also a need for demand side dispensation of social welfare benefits through cash transfers which will lead to more economic use of labor force as well as rationalize demand for food products.  Apart from these measures if Mr. Jaitley is to enforce strict legislations to effectively deal with hoarders and the ‘crooks’ who are trying to exploit apprehensions of a weak monsoon, it cannot be ignored that the government is the biggest hoarder of food grains with the FCI stocking in rice and wheat as well as other products like coarse grains, pulses and oilseeds which don’t have any replacement as such.

The hue and cry has already begun in the onion market with farmers complaining of exorbitant prices of inputs and low incentives.  As the Finance Minister struggles to take quick action by releasing FCI stocks and freeing some items from APMC’s purview, only time will tell how far this helps to reduce food prices in a year of poor monsoons. To add onto the distress the Iraq crisis has erupted in a time when the new government is formulating its Budget in a slow economy with high food inflation.  All we can do is to wait and watch how the Finance Ministry handles this delicate situation and whether or not the promising Modi Government fulfills its promises of strengthening the economy and propagates sustainable inclusive growth.

Nidhi is currently pursuing Economics in Lady Shri Ram College, Delhi University. She has a keen interest in global economic affairs. An avid reader, she loves writing on various topical issues in economics, politics and international affairs. She loves travelling and considers herself much of a movie buff.

Posted by The Indian Economist | For the Curious Mind