Low food inflation disadvantages farmers

The latest data for March shows the inflation rate to be 2.86 percent. The average inflation during the last fiscal year which ended in March is about 3.5 percent. This has been a remarkable success story, the credit for which should go jointly to the Reserve Bank of India and the NDA government. It was just three years ago that the RBI formally moved to inflation targeting, and this seems to be working. In fact, the inflationary expectations of households as tracked by the RBI has been steadily falling. This means that people are actually anticipating prices not to rise too steeply. If you say that inflation is falling, it always causes howls of protests, as some will say that medical and education costs are rising steeply in cities. But that is a selective perception. The fact is we have been on a disinflationary trend for the past five years.  The inflation rate is calculated on the basis of a basket of items including goods and services, which constitute the Consumer Price Index (CPI). Remember, that in November 2013 the CPI inflation peaked at 12 percent, which is the highest monthly number recorded in the past decade.

For India, half of the households are still connected directly or indirectly with agriculture. Low and negative food inflation means their incomes are also depressed. Unlike other non-food commodities, the demand for food does not jump up sharply, if prices fall. The demand is said to be inelastic. Hence falling prices usually spell falling incomes for farmers not rising quantities. Within the food basket, four items have seen a sharp downward price movement. These are fruits, vegetables, pulses and sugar.

Nearly half the items in the CPI basket are related to food and beverages. The weightage given to food related items is 46 percent. For the rural basket it is higher at 54 percent. So, when inflation is trending down, it has been heavily influenced by the decline in food inflation. Indeed, in the five months prior to February, food inflation was negative. The March food inflation was 0.3, just a little above zero. The food inflation for the whole of the last fiscal year was at 0.1, which is the lowest since 1991, as per a report by Crisil’s Chief Economist.

Having low and stable food inflation would be a cause for cheer, especially for urban consumers. In developed countries where urbanisation is close to 90 percent or higher, or where the farm population is not even 5 percent, food prices indeed remain low, affordable and stable. But for India, half of the households are still connected directly or indirectly with agriculture. Low and negative food inflation means their incomes are also depressed. Unlike other non-food commodities, the demand for food does not jump up sharply, if prices fall. The demand is said to be inelastic. Hence falling prices usually spell falling incomes for farmers not rising quantities. Within the food basket, four items have seen a sharp downward price movement. These are fruits, vegetables, pulses and sugar. Together they account for about 15 percent of the weightage. Their prices have been falling thanks partly to excess supply. We also had a period when we were importing pulses adding to the supply problem. Hence these four items have pulled down overall inflation. Cereal production too has gone up steadily in the past three years, adding to the supply effect.

The low prices and low income in farm households is what triggered policy responses like the Prime Minister Kisan Samman Nidhi (PM KISAN) scheme, which gives a direct cash transfer of 6000 rupees to every (small) farm household. The Minimum Support Price (MSP) regime also aims at giving the farmer a hefty 50 percent profit margin on the total cost of production. The MSP scheme did not work as envisaged, since actual procurement by Central and State governments was quite low, constrained by the tight fiscal situation. The government is also committed to doubling farm incomes, and is acutely aware of the downside of very low food inflation.

Historically India’s policy of industrialisation has had an urban and anti-agriculture bias. This resulted in the terms of trade being tilted against agriculture vis-a-vis industry. If there was a large decline in agricultural farm households, and corresponding increase in farm productivity, then we would have enjoyed the twin blessings of low food inflation and continued increase in farm production. But, unfortunately, people have not been able to migrate out of farming due to lack of secure jobs outside the farm sector. Farming as an activity itself suffers from multiple shackles. Price and quantity controls, the stranglehold of APMCs, antiquated laws on tenancy farming, control of moneylenders, prohibition of corporate farmer linkages, are some of the examples of the many shackles. The farm to fork value chain requires massive growth in agro processing, cold storage, spread of retail super markets and valued added products. This is still in the distant future.

While we wait for meaningful economic reforms in agriculture, and massive job creation in manufacturing, mining, real estate, construction and services sectors to suck out the surplus labour, we need to question whether near zero food inflation is acceptable.

Farming as an activity itself suffers from multiple shackles. Price and quantity controls, the stranglehold of APMCs, antiquated laws on tenancy farming, control of moneylenders, prohibition of corporate farmer linkages, are some of the examples of the many shackles. The farm to fork value chain requires massive growth in agro processing, cold storage, spread of retail super markets and valued added products. This is still in the distant future. 

A few years ago the RBI’s research department had published a report which shows that for India to maximise economic growth, its inflation rate has to be around 5 percent. This number is the mid-point of the inflation rate band that is targeted by the current RBI monetary policy framework. One can’t be sure of the exact growth maximising rate, but surely zero is too low. Disinflation leads to deflation, and a downward spiral of still lower price expectations. If people expect prices to fall, they postpone purchases, causing a fall in demand and rise in inventories, causing further discounting and price drops. This is dangerous for a developing country. Of course, such a logic applies to industrial goods, but can be applied to the agricultural sector too. If food inflation remains very low, we will urgently have to find ways to augment farm incomes from non-farm activity or outright cash transfers.

As of this writing more than 42 percent of India is officially under drought like conditions. Prices of fruits and vegetables can rise quickly, changing the food inflation scenario dramatically. Any fall in agricultural output will also reduce the excess supply effect, although sugar prices are unlikely to rise. If the MSP policies are enforced effectively and procurement quantities are increased, then farm distress can be somewhat mitigated. Near zero food inflation indicates that the urban versus rural trade pendulum may have swung too much to one side. It needs to reverse.

(The writer is an economist and Senior Fellow, Takshashila Institution)