Column: Wages, waste and WPI

Written by Sunil Jain | Updated: Apr 1 2013, 08:18am hrs
Almost all food inflation in the last 18 years can be explained by higher deficits, higher farm wages and global food price hikes

Though core inflation is finally below RBIs comfort zone of 4%, food inflation continues to be very high at around 10% and threatens to go out of control once againaccording to the World Banks latest quarterly food price report, drought in the US and dry spells in Argentina, South Africa and Australia could see global food prices go back to August 2012 record levels; a 1% rise in the global food price index causes a 0.3% hike in the domestic food price index. Should food prices rise, and the build-up to the Food Security Bill, which will hike procurement levels and lower free-market supplies will worsen things, this could trigger off yet another round of a wage-price inflation spiral. Severe mismanagement of cereal stocks by the public distribution system led to cereal prices rising 17.8% between March last year and February as compared to 3.4% in the year before thatanother round of food inflation hikes and you could see RBI even slowing down on its rate-cut cycle.

While many have blamed the shift in demand patternsa greater increase in consumption of protein-rich foods as India gets richerand the obvious lack of supply response for the rise in food inflation, others blame government entitlement programmes such as MGNREGA for causing wages to go up dramatically. The rupees depreciation has added to inflationary pressures, as has the runaway fiscal deficitthough the finance minister has finally managed to keep this under check, even if at a high level, sticking to deficit targets in an election year is very difficult.

A discussion paper by Commission for Agricultural Costs and Prices chairman Ashok Gulati and independent researcher Shweta Saini discusses the main reasons for food inflation in recent yearsthis averaged 10% a year between FY09 and December 2012, a huge tax on the poor considering they spend more than 60% of their monthly incomes on just buying food. Gulati and Sainis analysis starts off in 1995-96, the year in which India started exporting agriculture commodities since, at 18% of agri-GDP, the value of imports and exports means the sectors price levels are well integrated with those in global markets.

After examining various factors that could have an impact on food prices, Gulati-Saini zero in on three reasons which, they say, can explain nearly 98% of inflationary pressures in the last 16 yearsthe rise in fiscal deficits, the sharp spurt in rural wages and the higher levels of global prices. Unlike FE columnist Surjit Bhalla, Gulati and Saini dont think the hike in minimum support prices (MSP)usually based on CACP recommendationsis a cause for the rising food inflation since, they argue, higher MSPs result in a higher supply response which, in turn, dampens price rise; crops with MSPs, by this logic, have seen lower inflation than those without MSPs. This is also the reason why they feel a ban on exports will not help lower prices/inflation. A summary of their main findings:

* A 1% increase in the fiscal deficit for the study period increases money supply by 0.9%.

* After the government passed the fiscal responsibility bill in 2003, the fiscal deficit came down dramatically from almost 10% (Centre and states) of GDP in FY02 to 4% in FY08. Not surprisingly then, this was also the period of the lowest inflation in the country. Between FY09 and December 2012, thanks to the surge in the deficit, money supply rose by an average of 17% a year and food inflation by over 10%.

* A combination of greater MGNREGA spending and other government programmes has resulted in higher rural wagesbetween FY08 and FY12, real rural wages rose by 7% per annum, double that for the entire 16 year period they study. This, in fact, is also the reason for the higher MSP. A 1% hike in farm wages, their study shows, causes a 0.3% hike in the domestic food price index.

* The model explaining food inflation shows it has the highest response to the fiscal deficit, then to farm wages and to global food prices. A 1% hike in the fiscal deficit causes a 0.5% hike in the domestic food price index and a 1% hike in global food prices results in a 0.3% hike in the domestic food price index.

Given the constraints of populism especially in an election year, for instance, how does one fix things One option clearly is to increase the levels of transfer through Aadhaar-based direct benefit transfers. If 50% of PDS grain, for instance, doesnt reach the intended beneficiariesas the NSS data suggests is the casethen direct cash transfers will cut food subsidies by half, and help reduce the deficit. Another R1,00,000 crore can be gotand the deficit reduced accordinglyby selling 50 million tonnes of wheat lying in the PDS system and which is vastly in excess of what is required. While Gulati has been in favour of exporting the grain, others like National Statistical Commission chief Pronab Sen argue this makes things worsethe grain needs to be sold in the local market as this will augment supplies and drive down prices, apart from giving some relief to the exchequer which will get back some of the money it has blocked in grain purchases and storage.

Over the medium/long term, there are vital issues of completing irrigation projects to cover 30 million hectares of farm land and of modernising the supply chainsince FDI in retail hasnt taken off, the latter wont either. But few have any hopes of this being tackled in an election year.