By Samar Tyagi

Edited by Shambhavi Singh

Inflation means erosion of income for the people from the lower economic strata. For the past few years, it has been the headache for RBI which is entrusted to manage it. Raghuram Rajan (Governor, RBI) has attributed volatility in food prices to be chiefly responsible for this price trend. It is better to study why food prices have been rising by decomposing the trend for the past decades and see the prominence of factors involved.

The following chart shows that Indian agriculture is still dependent on Monsoon. Whenever there was deficient rainfall, it resulted in lesser production that ultimately pushed food prices in upward direction. This 30 year time series analysis gives a clear understanding of food price fluctuations owing to scanty rainfall.

 Source: RBI (2011)

If we closely observe the food price index for a longer period, we could notice two structural breaks, one at the beginning of financial year 2000-01 and the other in the middle of 2007-08 (Chart 2).Here, if we look closely, then we find that the average food inflation declined to 3.8 percent per annum during the 8-year period 2000-08 from 7.1 percent per annum in the second half of the 1990s. Although, GDP growth has been higher at 7.2 % per annum as against 6.7 % in the preceding period. In this period 2000-08, two years of deficient monsoon were observed 2002-03 and 2004-05, despite that food inflation remained contained. That means there are other factors working simultaneously and effect of monsoon is not dominating. In the subsequent 5-year period, 2008-09 to 2013-14 so far, not only has the average food inflation risen sharply to 10.3 per cent per annum, it has remained persistent.  Arguably the trigger for high food inflation emanated from the drought of 2009-10. But good rains in the following years have failed to douse food inflation. There are several other explanations such as the global food prices

graph 2

 Source: RBI (2011)

that also rose and Rupee depreciated vis-a-vis US Dollar, which made imports costlier and exacerbated domestic food inflation. But subsequent moderation in global food prices has not dampened our food inflation. Of course food inflation has come off its peak, but its persistence around double digit level suggests that that there must be something more fundamental at play. Let us look at food inflation data at a more disaggregated level.

image4

 Source: RBI (2011)

Chart 3 illustrates the share of food components whose weight has changed during the period 2005-13. When food inflation reached maximum, it is mainly led by protein and food products. In 2013, fruits and vegetables take the front seat and contribute more to food inflation than other factors.

graph 4

 Source: RBI (2011)

Chart 4 depicts food inflation measured by WPI (Wholesale price index) and CPI-IW (Consumer Price Inflation for Industrial wages). It is observed that both move coherently. CPI-IW shows more volatility in food inflation than WPI because of more share attached to it calculation of index.

Now we turn to the income factor. Post 1991 economic reforms, income growth has been very optimistic. Here we shall take household consumption expenditure surveys made available by the National Sample Survey Organisation (NSSO). It shows that the composition of food expenditure has changed in more recent years. As income level rises, generally the share of expenditure on food declines. Still in this declined share, there has been a significant increase in real expenditure on protein and vegetables in rural and urban areas across income deciles. Data for the years 1993-2012 suggest that it is only in the second half of the 2000s that annual average real expenditure turned slightly positive. But thereafter during 2010-12, the real average per capita expenditure has remained significantly positive. Moreover, there is greater allocation of expenditure away from cereals towards other forms of food items such as protein and vegetables. Hence demand seems to be the factor driving the prices of protein and vegetables.

Rural regions have made their food budget biased towards protein rich food, vegetables and fruits. This is made possible by increase in wage rate over this period. Some blame Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA) phenomenon to be responsible for this changed preference saying MNREGA led to increase in the income of wage earners. They increased their consumption on protein rich food items including vegetables and fruits. Sudden increase in demand of these superior good led to increase in food prices.

Table: Average annual growth in real @ household monthly per capita expenditure

Screenshot_2014-12-17-17-38-59~2

 Source: NSSO reports for various years.

R: Rural; U: Urban

@ Rural is deflated using CPI- AL (food) 1993-94=100 and Urban is deflated using CPI-IW (food) 1993-94 =100:

# Pulses, milk, egg, meat and fish

* Edible oils, beverage, sugar, salt and spices

Rising food prices can also be explained by the rising cost of doing agriculture. The cost of fuel and fertilisers has gone up because of high international oil prices combined with exchange rate depreciation. The dominant part of the cost of cultivation is labour. Indian agriculture is still largely driven by labour intensive technique. Generally the size of land holding is less, so mechanization is not preferred at small scale. Also the size of land holding declines for subsequent generations when a father has two or more children. His asset is distributed equally among all and each one of them has to establish separate or prepare whole set of equipments required for agriculture. Purchase of new equipments leads to rise in fixed cost and this translates into rise in prices of farm produce. Agricultural wages have shown a sustained increase since the mid-2000s. Even after accounting for inflation, real wage increase has been significantly positive. Non-agricultural wages too have shown similar increases in rural areas. There are several explanations why rural wages have increased. One explanation is that socially inclusive public policy such as Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) has set a floor to rural wages and increased the bargaining power of the work force. Although, in many regions the existing wage rates are more than the MGNREGA’s entitlements. But it decreased the available labour supply to agriculture resulting in increases in bargaining power of labour. Admittedly, when GDP was rising faster, real wage increase could be somewhat benign, but real wage increase continued to remain significant even as GDP growth decelerated. Thus the wage catch up period seems to have overshot economic growth cycle (Chart 5).

graph 5

 Source: RBI (2011)

There are other factors too that have contributed in food price rise over these years. Transmission of global food prices too has been obvious. India has imported food grains and sugar too with other food commodities, which resulted in rise in global food price rise owing to large speculation in food market that foreign investors take advantage of. Next another prominent reason is rise of MSP (Minimum Support Price) in these years. Higher MSP translates in higher price for food grains.

Next ambiguous reason is forward trading in food commodity. Food commodities like other commodities in share market are traded. Sometimes, speculation lead to volatility in prices and food prices changes as it sets the benchmark in advance for buyers and sellers. There is lack of study in this field that can claim the precise estimate of role of forward trading responsible for food price rise in India.

Thus, we see that there are many factors responsible for food price rise. Until, policymakers work on immediate causes, result would be very poor as has been the case.

Samar Tyagi is currently pursuing his Master’s degree in Economics from Banaras Hindu University, Varanasi. He is more interested in investigating International Economic Relations and studying Development issues. He has interned at Institute of Chinese Studies, Delhi exploring Sino-Indian trade relations. He also did an intensive field survey while studying the loss of livelihood for weavers in Banaras suburban region. Apart from serious economics, he loves travelling and enjoying different recipes

Posted by The Indian Economist | For the Curious Mind