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Cash transfers to tame food price spiral-Ashok Gulati and Shweta Saini
-The Economic Times
Inflation
Food inflation in India, as measured by food articles price index, has averaged 11.3% for the period FY 2008-09 to December 2012, with a maximum of 15.6% in 2010-11 and minimum of 7.3% in 2011-12. In December 2012, wheat prices stood 23% higher than in December 2011, and rice prices 17% higher in the same period. Although this spurt in wheat and rice prices in the face of overflowing grain stock is purely due to suboptimal grain management, resurgence of food inflation is posing a challenge to policymakers.

It is well-recognised that high food inflation could be the worst form of 'hidden tax' in a country where an average household spends almost half of its expenditure on food, and poor spend even more than 60% on food. So, there are no two views on the urgent need to contain food inflation below the comfort zone of 5%.

However, lately, the reluctance of RBI to reduce interest rates unless the government reduces fiscal deficit also highlights the trade-off between growth and inflation. RBI understands fully that reducing interest rates will increase liquidity in the economy, putting further pressure on prices, both food and non-food, and that would be inflicting a severe blow to the poor, who cannot easily hedge against high inflation. This prompted us to investigate the factors influencing Indian food inflation over a longer period, from 1995-96 to December 2012. A better diagnostic would obviously aid in rational and effective policy formulation to rein in food inflation to acceptable levels.

Our findings reveal that Indian food inflation, measured by the Food Articles Index (FAI) from 1995-96 to December 2012, can be almost fully explained by three factors: fiscal deficit (FD), global food inflation and domestic farm wages.

As one can see in the accompanying graphic, FD measured in Indian billion rupees expanded drastically in 2008-09 and 2009-10. This sudden jump in FD — that also led to substantial expansion of M3 — was a consequence of a well-thought-out policy of giving "fiscal stimulus" to the economy to avert any fears of recession that the western countries were facing. In fact, this package of fiscal stimulus was conceived and orchestrated by G8 plus five countries, and India was a part of that symphony.

One may recall various measures ranging from wage increases under Sixth Pay Commission to farm loan waivers and expanded MNREGA, etc, that were taken just before the parliamentary elections of 2009. All these policies pumped in too much money chasing too few goods. No wonder India's food inflation rose sharply thereafter.

The second critical factor influencing domestic food prices has been global food inflation itself. Global food prices literally erupted in 2007-08, experienced a little dip in the second half of 2008, but then started rising again. There are several theories trying to explain the forces behind global food price rise, ranging from foodfuel link — US' decision to put large quantities of corn, almost 125 million tonnes, in biofuels — to rigging of agri-futures markets by fund managers in US. We don't intend to go into the details of those theories, but suffice it to say that Indian food inflation is not insulated from what is happening to food prices globally.

Although India does protect itself from spikes and troughs in global prices of food through export bans — as was the case with rice and wheat in 2007-08 — or by imposing prohibitively high import duties, Indian food prices do follow the trend in global food prices in most commodities, more so from 2000 onwards (see graphic).

Third factor, interestingly, is the farm wage in India. The farm wage rate index is constructed by combining wage rates for five different farm operations — ploughing, sowing, weeding, transplanting and harvesting — for 16 major states that have 93% of farm labour, weighing each state by its share of farm labour in all-India farm labour force, and indexing it by taking 2004-05 wage rate as 100. As shown in the graphic, these wage rates have risen sharply, especially 2007-08 onwards. Several reports indicate that MNREGA expansion has led to a sharp increase in farm wages, making Indian agriculture expensive and food prices, therefore, a result of this "cost-push" inflation. Our state-wise analysis at CACP, however, reveals that MNREGA is only one factor and, in many states, a minor one, in pushing up farm wages. Bigger factors are the growth in construction sector as well as revival of agricultural growth in many states. But, sure enough, farm wages do have a strong influence on food prices via rising costs of production.

These three factors, i.e., domestic fiscal deficit, global food prices and domestic farm wages, when put in a log-linear equation, explain more than 98% variation in prices of Indian food articles, and all of them are statistically very significant.

What does it mean for policies to tame food inflation? First, one needs to bring down fiscal deficit in a calibrated manner, preferably by pruning subsidies and non-investment expenditures. Our calculations at CACP suggest that food and fertiliser subsidies can be pruned by almost.`60,000 crore in 2013-14, if one moves through direct cash transfer route using Aadhaar in case of food and fertilisers to direct beneficiaries.

Second, by liquidating excessive grain stocks in the domestic market or through exports, massive savings of non-productive spending can be realised. Against a buffer stock norm of 32 million tonnes (mt) of grain, India had 80 mt of grain on July 1, 2012, and this may cross 90 mt in July 2013. Even if one wants to keep 40 mt of reserves in July, liquidating the remaining 50 mt can bring .`80,000-1,00,000 crore back to the exchequer. And, with this much grain in the market, food inflation will certainly come down.

Third, to contain wage costs in agriculture, MNREGA can be dovetailed to agrioperations, wherein farmers pay a part of the wage payment (say, .`100 a day) and the other part (say, another .`100 a day) is paid through MNREGA. Such group-wise agri-operations can be organised through panchayats. This would keep the agricosts under control, give more income to farm labour and also keep farm labour more productive. There is urgent need to undertake this fusion.

Lastly, global food inflation is not within India's direct control, but India can moderate its influence, especially of spikes, on domestic prices by an active and variable tariff structure, rather than outright bans on exports or imports.

Hopefully, action on these policy fronts can tame this monster of food inflation that is eroding the confidence of the Indian growth story.

(A Gulati is chairman of the Commission for Agricultural Costs and Prices and S Saini is an independent researcher and consultant. Views are personal)