Vivek Kaul
Buried somewhere in the Reserve Bank of India‘s first quarter review of monetary policy released yesterday is the following paragraph:
The stickiness in inflation, despite the significant growth slowdown, was largely on account of high primary food inflation, which was in double-digits during Q1 of 2012-13 due to an unusual spike in vegetable prices and sustained high inflation in protein items.
In simple English what this means is that despite economic growth slowing down inflation continued to remain high because of high food inflation. The Reserve Bank of India (RBI) has not seen the last of food inflation and there are several reasons why food inflation will continue to remain high in the days to come.
Below average rainfall: The immediate reason for the food prices continuing to remain is the below average rainfall this monsoon season. As the RBI said in the first quarter review of monetary policy:
During the ongoing monsoon season, rainfall up to July 25, 2012 was 22 per cent below its long period average (LPA). The Reserve Bank’s production weighted rainfall index (PWRI) showed an even higher deficit of 24 per cent. Further, the distribution of rainfall was very uneven, with the North-West region registering the highest deficit of about 39 per cent of LPA. If the rainfall deficiency persists, agricultural production could be adversely impacted.
The availability of water can make a huge difference to the agricultural output in India. Areas fed by canals form only around 40% of the total arable land in India. The remaining 60% are dependent on rains. With deficient rains this year the current khareef crop is likely to be impacted with production not being enough to meet demand. This will lead to food prices going up in the days to come.
Rural India is eating better: The various social schemes being run by the current United Progressive Alliance (UPA) government have put more money into the hands of rural India. The income of rural India has more than doubled in the last five years. One thing that seems to have happened because of this is that people are eating better than before. Economists are of the opinion that as income of people rises above the subsistence level of $1000 per year, a substantial portion of the new money is spent on food. People eat more and better quality food. At the same time they also move from cereal based diets to more protein based diets. In major parts of the world this means that people start consuming more meat. But India has a lot of vegetarians and hence consumption of other high protein food items like dal, milk and other dairy based products has gone up, pushing their prices up. This is likely to continue in the months and years to come given the social commitment of the current UPA government. If the proposed Right to Food Act goes through you could see a further increase in food prices.
The Japan syndrome: As a densely populated country industrialises, the area under agriculture tends to go down. This phenomenon was first observed in Japan, and has since then been observed in South Korea, Taiwan, and very recently China. As Lester R Brown points out in Outgrowing the Earth: The Food Security Challenge in an Age of Falling Water Tables and Rising Temperatures “First, as a country industrialises and modernises cropland is used for industrial and residential development. As automobile ownership spreads, the construction of roads, highways, and parking lots…takes valuable land away from agriculture…. Secondly as rapid industrialisation pulls labour out of the countryside, it often leads to less double cropping, a practice that depends on quickly harvesting one grain crop once its ripe and immediately preparing the seedbed for the next crop…Third, as incomes rise, diets diversify, generating demand for more fruits and vegetables. This in turn leads farmers to shift land from grain to these more profitable high-value crops.”
This is a long term phenomenon which is clearly playing out in India right now. Just drive around towards the outer limits of the city you live in and you will realize that what was once agricultural land has been taken over to build malls, apartments, offices etc. This leaves less area to grow vegetables, cereals and other crops, pushing up their prices in turn. Depleting aquifers: A huge amount of increase in the irrigation of crops across the gangetic plane, India’s agricultural heartland have substantially depleted the aquifers or the underground water tables. As a report by DWS Investments points out “Dramatic increases in the irrigation of crops across northern India have substantially depleted the region’s groundwater. Between April 2002 and August 2008, aquifers lost a total of more than 54 cubic kilometers per year. That decrease in groundwater is even more than double the capacity of India’s largest reservoir.”
While this data is around four years old there is no reason to believe that the situation could have improved in the last four years. It could only have got worse. This is something that Brown agrees with in his book Outgrowing the Earth. He writes “the extensive overpumping of aquifers in India will deprive farmers of irrigation water and will also reduce grain production”.
Climate change also threatens food security: As the following table points out Indian agriculture has very low productivity when it comes to other parts of the world. Even Bangladesh does better than us when it comes to producing rice.
Comparing productivity of Indian agriculture with the world (kg/ha)
Country Paddy Country Wheat Country Maize
World 4,223 World 2,829 World 5,010
Bangladesh 4,012 China 4,608 Agentina 7,666
Brazil 3,826 Egypt 6,478 Canada 8,511
China 6,422 France 6,256 China 5,151
India 3,303 India 2,704 India 2,440
Indonesia 4,705 Italy 3,568 Italy 9,144
Japan 6,511 Spain 3,470 Turkey 6,838
USA 8,092 United Kingdom0 7,225 USA 9,458
Source: Agriculture Statistics at a Glance /Kotak GameChanger Report
Even this production is threatened now because of rising global temperature which beyond a certain point tends to reduce the amount of crop produced. As Lester Brown told me in an interview I did for the Daily News and Analysis (DNA) a few years back “For each degree celsius rise in temperature above the norm during the growing season, farmers can expect a 10% decline in wheat, rice, and corn yields. Since 1970, the earth’s average surface temperature has increased by 0.6 degrees Celsius, or roughly 1 degree Fahrenheit.”
As the earth’s temperature rises it has led to glaciers melting. “Nowhere is this of more concern than in Asia. It is the ice melt from glaciers in the Himalayas and on the Tibetan plateau that sustain the major rivers of India and China, and the irrigation systems that depend on them, during the dry season. In Asia, both wheat and rice fields depend on this water. China is the world’s leading wheat producer. India is No 2 (The US is third.) These two countries also dominate the world rice harvest. Whatever happens to the wheat and rice harvests in these two population giants will affect food prices everywhere. Indeed, the projected melting of the glaciers on which these two countries depend presents the most massive threat to food security humanity has ever faced,” said Brown.
Cars and people are competing for grains: As the price of oil keeps going up, the world has started to look for alternate sources of fuel to run cars and other forms of transport around the world. One such fuel is ethanol which is made from corn and sugarcane in different parts of the world. In Brazil, a lot of cars run on ethanol, which is produced using sugarcane. So if oil prices go up, ethanol becomes more viable as an alternate fuel. And this pushes up the price of ethanol input, i.e. sugarcane. With lesser sugarcane available to produce sugar, the price of sugar also goes up. The United States uses corn to make ethanol. So oil prices going up leads to corn prices going up as well. As Brown put it “If the fuel value of grain exceeds its food value, the market will simply move the commodity into the energy economy. If the price of oil jumps to $100 a barrel, the price of grain will follow it upward. If oil goes to $200, grain will follow. From an agricultural vantage point, the world’s appetite for crop-based fuels is insatiable. The grain required to fill an SUV’s 25-gallon tank with ethanol just once will feed one person for a whole year. If the entire US grain harvest were to be converted to ethanol, it would satisfy at most 18% of US auto fuel needs.”
Given these reasons the food prices are likely to remain high in the months and years to come. And the Reserve Bank of India can fiddle around with the interest rates as much as it wants to, but there is no way it can control food prices.
(The article originally appeared on www.firstpost.com on August 2,2012. http://www.firstpost.com/economy/why-food-prices-will-continue-to-rise-in-the-coming-years-400532.html)
(Vivek Kaul is a writer and can be reached at [email protected])
Month: August 2012
A policy rate Catch 22
Vivek Kaul
“That’s some catch, that Catch-22,” says Yossarian, the lead character in Joseph Heller’s all time classic Catch 22. Duvvuri Subbarao, the governor of the Reserve Bank of India (RBI) is facing a Catch 22 situation currently and some catch it is.
He needs to decide whether to encourage economic growth or to control inflation. Theoretically Subbarao can encourage economic growth by cutting the interest rates. But that is likely to fuel inflation as people and companies will borrow and spend more, leading to a rise in prices.
He can control inflation by keeping the interest rates high. But that kills economic growth as businesses don’t borrow money to expand and people go slow on taking loans for purchasing cars, motorcycles, homes and consumer durables. This hurts businesses and slows down economic growth.
The RBI seems to be trying to control inflation by keeping the interest rates high rather than try and encourage economic growth by cutting the interest rate. In the first quarter review of monetary policy 2012-2013 which was released on July 31, 2012, the RBI decided to keep the repo rate at 8%. Repo rate is the interest rate at which the RBI lends to banks.
By keeping the repo rate high the RBI hopes to control inflation. “The primary focus of monetary policy remains inflation control,” the RBI said in a statement. But economic theory and practice don’t always go together.
The inflation in India is primarily on account of rising oil prices and food prices. Oil is a commodity that is bought and sold internationally and the RBI cannot control its price. The price of oil has been falling since the beginning of this year but it has started to inch its way back up and as I write this, brent crude oil is quoting at $105per barrel. While the government has shielded the people from a rise in oil price by not raising the price of diesel, LPG and kerosene, petrol prices have been raised.
As far as food is concerned there seems to be a structural shift happening. “The stickiness in inflation…was largely on account of high primary food inflation…due to an unusual spike in vegetable prices and sustained high inflation in protein items,” the RBI said.
Protein items primarily include various kinds of pulses, milk and other dairy items. The various social schemes being run by the current United Progressive Alliance (UPA) government have put more money into the hands of rural India. One thing that seems to have happened because of this is that people are eating better than before.
Economic theory suggests that once income levels rise above $1000 per annum, a major portion of the increased income is spent on more food and better quality food. Also people shift from cereal based diets to protein based diets. In large parts of the world this means an increase in the consumption of meat. But in India it means more consumption of milk and pulses. Again this is something that the RBI has no control over. As long as the UPA keeps running its social schemes this phenomenon of increased food prices is likely to continue.
What does not help in the near term is a deficient monsoon. Rainfall upto July 25,2012 has been 22% below its long period average. This means food prices will continue to rise.
What this clearly tells us is that RBI is not in a position to control inflation as it stands today. So should it be cutting the repo rate and in the process encouraging economic growth?
When RBI cuts the repo rate it is essentially giving a signal to banks that it expects the interest rates to go down in the days to come. But it is upto the banks to decide whether they take that signal seriously. When the RBI cut the repo rate by 50 basis points (one basis point is one hundredth of a percentage point) in April, the banks cut their interest rates by only 25 basis points on an average.
The reason was the increased borrowing by the government to finance its growing fiscal deficit. Fiscal deficit is the difference between what the government earns and what it spends. Between 2007 and 2012 the fiscal deficit of the government has gone up by more than 300%. During the same period its income has increased by just 36%.
The fiscal deficit has been growing on account of various subsidies like oil, food and fertizlier being offered by the government. “During April-May 2012, while food subsidies were lower, fertiliser subsidies were more than twice the previous year’s level,” the RBI statement pointed out. What also does not help is the fact that the Rs 43,580 crore oil subsidy budgeted for this year has already run out. The government compensates the oil marketing companies (OMCs) for selling kerosene, diesel and LPG at below cost. With oil prices over $100 again, the oil subsidies are likely to increase in the days to come.
This means increased borrowing by the government to compensate the OMCs for their losses. Increased borrowing by the government will mean that banks will have a lower pool of money to borrow from and hence they will have to continue to offer high interest rates on their deposits and charge high interest rates on their loans.
So what is the way out? “Clearly, if the target of restricting the expenditure on subsidies to under 2 per cent of GDP in 2012-13, as set out in the Union Budget, is to be achieved, immediate action on fuel and fertiliser subsidies will be required,” the RBI said.
But raising prices is easier said than done. Another theory being bandied around is that Duvvuri Subbarao is Chiddu’s baby (P Chidambaram, the Home Minister) and he will start cutting the repo rate as soon as Chidambaram is back at the Finance Ministry.
(The article originally appeared in the Asian Age/Deccan Chronicle on August 1,2012. http://www.asianage.com/columnists/policy-rate-catch-22-677)
The article was written before P Chidambaram was appointed as the Finance Minister
(Vivek Kaul is a Mumbai based writer and can be reached at [email protected])