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Economy Apr 2, 2013

How the govt itself stoked the fires of food inflation

By Vivek Kaul

Hindi film songs have words of wisdom for almost all facets of life. Even inflation.

As the lines from a song in the 1974 superhit Roti, Kapda aur Makan go, "Baaki jo bacha mehangai maar gayi (Of whatever was left inflation killed us)."

Inflation has been whacking Indian budgets over the last few years. What has hurt the common man even more is food inflation. Food prices have risen at a much faster pace than overall prices.

Reuters

During the period 2008-09 to December 2012, wholesale price inflation, a measure of the overall rise in prices, averaged 7.4 percent. Reuters

A discussion paper titled Taming Food Inflation in India, released on 1 April by the Commission for Agricultural Costs and Price(CACP), which sets minimum support prices for foodgrains, points out to the same. "Food inflation in India has been a major challenge to policy makers, more so during recent years when it has averaged 10 percent during 2008-09 to December 2012. Given that an average household in India still spends almost half of its expenditure on food, and the poor around 60 percent (NSSO, 2011), and that the poor cannot easily hedge against inflation, high food inflation inflicts a strong 'hidden tax' on the poor...In the last five years, post 2008, food inflation contributed to over 41 percent to the overall inflation in the country," write the authors Ashok Gulati and Shweta Saini. Gulati is the Chairman of the Commission and Saini is an independent researcher.

During the period 2008-09 to December 2012, wholesale price inflation, a measure of the overall rise in prices, averaged 7.4 percent. In the same period the food inflation averaged 10.13 percent per year.

So who is responsible for food inflation, which is now close to 11 percent? The short answer is the government. As Gulati and Saini write: "The Economist in its February 2013 issue highlights that it was the increased borrowings by the Indian government which fuelled inflation...It categorically puts the responsibility on the government for having launched a pre-election spending spree in 2008, which continued even thereafter."

Gulati and Saini build an econometric model which helps them conclude that the "fiscal Deficit, rising farm wages, and transmission of the global food inflation, together they explain 98 percent of the variations in Indian food inflation over the period 1995-96 to December 2012...These empirical results clearly indicate that it would not be incorrect to blame the ballooning fiscal deficit of the country today to be the prime reason for the stickiness in food inflation."

Fiscal deficit is the difference between what a government earns and what it spends. In the Indian context, it has been growing in the last few years as the government has been spending substantially more than what it has been earning.

The fiscal deficit of the Indian government in 2007-08 stood at Rs 1,26,912 crore. This jumped by 230 percent to Rs 4,18,482 crore in 2009-10. This was primarily because the expenditure of the Congress-led UPA government went up at a much faster pace than revenues.

The government of India had total expenditure of Rs 7,12,671 crore in 2007-08. This grew by nearly 44 percent to Rs 10,24,487 crore in 2009-10. The income of the government went up at a substantially slower pace. Between 2007-08 and 2009-10, the revenue receipts (the income that the government hopes to earn every year) of the government grew by a minuscule 5.7 percent to Rs 5,72,811 crore.

And it is this increased expenditure (reflected in the burgeoning fiscal deficit) of the government that has led to inflation. As Gulati and Saini point out, the "Indian fiscal package largely comprised of boosting consumption through outright doles (like farm loan waivers) or liberal increases in pay to organised workers under the Sixth Pay Commission and expanded MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) expenditures for rural workers. All this resulted in quickly boosting demand."

So the increased expenditure of the government was on giving out doles rather than building infrastructure.

This meant that the money that landed up in the pockets of citizens was ready to be spent - and was spent - sooner rather than later. "But with several supply bottlenecks in place, particularly power, water, roads and railways, etc, very soon, 'too much money was chasing too few goods'. And no wonder, higher inflation in general and food inflation in particular was a natural outcome," write the authors.

So increased expenditure of the government led to increasing demand for goods and services. This increase in demand was primarily responsible for the economy growing by 8.6 percent in 2009-10 and 9.3 percent in 2010-11. But the increase in demand wasn't met by an increase in supply, simply because India did not have the infrastructure required for increasing supplies of the items in demand. And this led to too much money chasing too few goods.

No wonder this sent food prices spiralling. Food prices have continued to rise as government expenditure has continued to go up. Also food prices have risen at a much faster pace than overall prices. This is primarily because agricultural prices respond much more to an increase in money supply vis-a-vis manufactured goods where prices tend to be stickier due to some prevalence of long-term contracts. As Gulati and Saini put it, "In fact, our analysis for the studied period shows that a one percent increase in fiscal deficit increases money supply by more than 0.9 percent."

The other major reason for rising food prices is the rising cost of farm wages. This pushes inflation at two levels. First is the fact that an increase in farm wages drives up farm costs and that in turn pushes up the prices of agricultural products. As the authors point out, "During 2007-08 to 2011-12, nominal wages increased at much faster rate, by close to 17.5 percent per annum...The immediate impact of these increased farm wages is to drive-up the farm costs and thus push-up the farm prices, be it through the channel of MSP (minimum support price) or market forces."

Rising farm wages also lead to a section of the population eating better and which in turn pushes up the price of protein food. As Gulati and Saini point out, "This study finds that the pressure on prices is more on protein foods (pulses, milk and milk products, eggs, fish and meat) as well as fruits and vegetables, than on cereals and edible oils, especially during 2004-05 to December 2012. This normally happens with rising incomes, when people switch from cereal-based diets to more protein-based diets."

In the recent past, the prices of cereals like rice and wheat have also gone up substantially. This is primarily because the government is hoarding much more rice and wheat than it requires to distribute under its various social programmes.

If food inflation has to come down, the government has to control expenditure. The authors suggest several ways of doing it. The government can hope to earn Rs 80,000-100,000 crore if it can get around to selling the excessive grain stocks that it holds. Other than help control its fiscal deficit, the government can also hope to control the price of cereals like rice and wheat which have been going up at a very fast rate by increasing their supply in the open market.

"By liquidating (i.e selling) excessive grain stocks in the domestic market or through exports, massive savings of non-productive expenditures can be realised. For example, as against a buffer stock norm of 32 million tonnes of grains, India had 80 million tonnes of grains on 1 July 2012, and this may cross 90 million tonnes in July 2013. Even if one wants to keep 40 million tonnes of reserves in July, liquidating the remaining 50 million tonnes can bring approximately Rs 80,000-100,000 crore back to the exchequer. And with this much grain in the market, food inflation will certainly come down. Else, the very cost of carrying this 'extra' grain stocks alone will be more than Rs 10,000 crore each year, counting only their interest and storage costs."

Of course this has its own challenges. More than half of this inventory of grain in India is concentrated in the states of Punjab and Haryana. Moving this inventory from Punjab and Haryana to other parts of the country will not be easy, assuming that the government opts to work on this suggestion. At the same time the government will have to do it in a way so as to ensure that the market prices of rice and wheat don't collapse. And that again is easier said than done.

The authors also recommend that the government can cut down on food and fertiliser subsidy by directly distributing it. "By going through the cash transfers route (using Aadhaar), one can plug in leakages in PDS (public distribution system) which, as per CACP calculations, are around 40 percent, and save on high costs of storage and movement too, saving in all about Rs 40,000 crore on food subsidy bill," write Gulati and Saini.

Something similar can be done on the fertiliser front as well. "Fertiliser subsidy, if given directly to farmers on a per hectare basis (Rs 4,000/ha to all small and marginal farmers which (sic) account for about 85 percent of farmers; and somewhat less (Rs 3,500 and Rs 3,000/ha) as one goes to medium and large farmers, and deregulating the fertiliser sector can bring in large savings of about Rs 20,000 crore along with greater efficiency in production and consumption of fertilisers."

Whether the government takes these recommendations of the CACP seriously remains to be seen. Meanwhile, here is another brilliant Hindi film song from the 2010 hit Peepli Live: "Sakhi saiyan khoobai kaamat hain, mehangai dayan khaye jaat hai (O friend, my beloved earns a lot, but the inflation demon keeps eating us up)."

Vivek Kaul is a writer. He tweets @kaul_vivek

by Vivek Kaul

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