Inflation in 2006-07 was fuelled by the rise in prices of primary articles, even though the prices of manufactured products rose at a much higher rate. This draws attention to the terms of trade or relative price trends between agriculture and other sectors. A sudden rise in farm-produce prices does not necessarily fill the pockets of farmers and lead to new investments. Also, the changes in the Indian economy over the last two decades mean that competition for capital between agriculture and manufacturing is not as significant as it could have been.
The terms of trade between agriculture and the rest of the economy do, however, point to changes in the supply-demand imbalances across sectors. To induce new investment, either rising margins of profit or rising volume of business are necessary. In the case of agriculture, what will it be?
The terms of trade, estimated as the ratio of agricultural prices to manufactured product prices, offer a rough indicator of relative attractiveness of the agricultural sector for investment. However approximate, it reflects the fact that when prices of farm products are rising faster than those of manufactured products, many of which would be agricultural inputs, the returns to investment in agriculture would improve. It is certainly not a measure of welfare, as rising agricultural prices (especially of food items), would mean costlier sustenance to the poor.
During the period when agricultural growth was the best in recent times, 1992-96, the terms of trade were improving for agriculture. Agricultural GDP increased by an average of 4.7% per year during this period. In the next ten years, the growth was about half this rate, and the terms of trade were declining for agriculture (until the last couple of years of the decade).
In the most recent five-year period, investment in agriculture was stagnant as a percentage of GDP. The Eleventh Five-year Plan is looking at raising agricultural output at 4% per year. This won?t be easy. Clearly, more investment would be needed to accelerate growth. This will require a conducive investment climate for the farm sector.
Slower rise in prices and slower growth in output point to the key weakness of agriculture?that of limited markets. It is not clear what the Doha round is likely to achieve in terms of access to world markets for Indian agriculture. But improving the terms of trade is an important variable for improving the investment climate in the sector. If it is not the volume, margins would have to increase for more investments. Better margins may not necessarily come from higher prices, but also from a larger share of higher-value output.
The correlation between the relative prices and agricultural growth, while plausible, is clearly not the entire explanation for the pace of agricultural output growth. The other ways of inducing farmers to invest and improve productivity through subsidies, expansion of markets or reducing risks, are more effective in achieving the same goals. Sharp fluctuations in prices have led to severe shocks to the farm sector in the past. High and unsustainable prices have led to unwise investments and low prices have led to borrowing at high interest rates. The farm sector has not been able to withstand the large shocks.
Generic support systems, such as directed credit, have been the main form of inducing new investments. Crop-specific support systems, such as high-yield seeds and support prices, tend to have short-term impact and require continued interventions. The more generic form of support provides greater choice to farmers in terms of crops they can grow and move up the value chain of agriculture. Gaining favourable terms of trade, therefore, is not a sufficient condition for bringing about more investment into agriculture. It can be a catalyst in the process, but for sustaining investment, other productivity enhancing measures and market expansion measures would be needed.
What is of importance in influencing the course of agriculture is government policy. The link between the terms of trade and policy is quite unclear. Does government-sponsored capital formation pick up when the terms of trade are moving against agriculture, or the other way around? In the past five years, it was government spending that was sustaining growth in agricultural investment. It is, therefore, likely that the agricultural growth rate has greater influence on government policy: sagging growth induces more spending.
The policy target has typically been food output. Steady improvement of farm incomes is a more appropriate if difficult goal to achieve. Recommendations made by the National Commission on agriculture seek to move policy in this direction. But clearly, it should be farmers? own decisions that should drive investment in this sector. This requires both volumes and margins. There are clear signals that public investment in the rural sector as a whole is increasing. Rural development programmes aim to improve infrastructure. Then again, this is but one element of a strategy to improve the investment climate for agriculture.
?Shashanka Bhide is senior Research Counsellor, NCAER. These are his personal views