Why have onion prices flared up?

Onion prices have been generally very volatile this year. At the start of the year in January, the prices touched a record of around Rs 25 in the major cities, which was a thirteen-year high. But just four months later in May, the prices slumped to the Rs 11-12 range, the lowest in two decades, mainly on account of the record rabi output of 5.35 lakh tonnes. And now, seven months later in December, onion prices have once again shot up above Rs 60, mainly because the rains have reduced production by almost a third in the current season.

Have only onion prices flared up in recent times?

The trend is mixed. If you look at the wholesale food prices, the numbers show that overall food prices have gone up by 12.1% on a year-on-year basis. Though still higher than the overall rate of inflation, the scenario is not too bad as the food prices had shot up by a far higher 21.1% in the corresponding period of the previous year.

The higher food prices are mainly on account of a number of products, especially vegetables, fruits, milk, egg, meat and fish. While annualised figures show that vegetable prices are going up by 15.4% nudged up by onion prices, potato, another major vegetable, has seen prices slump by 28%, primarily because potato prices had more than doubled in the corresponding period of the previous year. And now prices of tomatoes are also moving up.

But what makes the scenario particularly bad for the middle class is that the most recent wholesale price index shows that prices of fruits are going up by 20%, while that of milk by 18% and egg, meat and fish by 19%. What makes it worse is that this increase is over and above the double-digit increase in these prices in the previous year too.

The only saving grace is that prices of cereals are now falling, albeit marginally, by a few decimal points. This is mainly on account of the 5% fall in wheat prices. Price of rice is, however, moving up by a marginal 1.4%.

Are hoarders responsible for the hike?

Not really. When there are shortages, some traders would like to hold back some stocks, awaiting higher prices. But supply actually depends on the flow of products into the markets. This is especially true in the current scenario where most of the products facing price pressures are perishable commodities such as vegetables, fruits, milk, eggs and so on, where the shelf life is too small to permit hoarding.

Evidence shows that the bulk of the increase takes place?around 80-100%?by the time products reach retailers because there are typically 5-7 intermediaries in the middle.

Should government raise interest rates to tackle this?

Monetary policy is a very powerful weapon to tackle inflation. Higher rates reduce productive activities and bring down prices, as demand slumps due to higher interest rates. But using such a tool to bring down food prices would ensure large collateral damage to the whole economy. The impact on food prices would be minimal as the high prices are mainly on account of supply shortages. Moreover, the impact of monetary policy is lagged, with the signs visible after a few months by when the supply would have already bounced back.

So why are prices of foodstuff rising?

The reasons are many. High growth over the decade has pushed up per capita income and consumption of households. Supply has not kept pace as food production has increased much more slowly. New welfare schemes like the MGNREGA have helped the poor to protect their basic consumption patterns. That is on the demand side. On the supply side, the sharp increase in minimum support prices has pushed up farm prices. And the prices of inputs like fertilisers and pesticides have gone up. So have farm prices. Rising land prices have increased the wealth of farmers near urban centres and has distracted them from farming.

What can the government do?

Large food stocks, which is higher than the buffer norms, reduce supply and push up demand. In fact, one reason why the prices of rice and wheat have come down is that the government has released more stocks from government godowns in recent months. But the real solution is boosting supply through increased production. This is especially true of perishable products such as fruits, vegetables, milk and eggs. Farmers are now generally wary of pushing up production of perishable goods as they have to often sell it at distress prices. Only good infrastructural facilities such as roads and cold storage facilities, which help market the product at remunerative prices, will provide real incentives for farmers to boost production. Futures markets, which provide medium-term price signals, also have a useful role to play in reducing farmers risks.

How important is food inflation?

Food inflation is a major issue for the poor, who account for a quarter of the population. They spend a major part of their income on food and rising food prices have a sizeable impact on their real wages. But the overall impact of food prices has reduced significantly, with the share of food in the total consumption basket shrinking rapidly. Most recent surveys indicate that food consumption accounts for 52% of the total household spending in rural areas and 40% in urban areas.

So…

So the impact of food prices on consumption and the overall economy has come down in the recent period. The best evidence is that consistently high food prices in recent years have not been transmitted to the manufactured goods prices. Although food prices continue to rise in double-digits, the manufactured goods prices are rising by less than half the level. The rising productivity in the sector and the imports have helped contain the impact of the overall increase in food prices on the manufacturing sector.

How serious a problem is inflation?

The impact of inflation is worst on the marginal sections. It is a big hassle for the political leadership as prices are a major issue in the electoral battles and swings sentiments of the less well-off section against the incumbent.

So, it means that the poor are getting poorer…

Inflation hurts the poor. But the impact is far less than it used to be in the earlier decades. Studies, in fact, show that income levels of even the lowest 10% of the population are now growing faster than inflation. But while this is generally true of the country as a whole, it might not hold for all, given the disparate trends in growth of incomes and consumption across the country.