Much to everyone’s relief, inflation has begun to ease led by a sharp fall in food prices. This has sparked a clamour for monetary easing as most likely, headline CPI inflation may undershoot the 8% target for January 2015. But RBI has not yielded as yet; it remains more focused on the medium-term outlook, especially the 6% glide path target set for January 2016. Its caution is guided by its model, which projects inflation to return to 6% levels in 2015-16 from a 4.4% low in November 2014 as base effects wane and absent any visible supply response, food prices come under renewed pressure with acceleration in aggregate demand.
Arguably however, the drivers of food inflation have so significantly weakened that suggestions of any sharp reversal in 2015-16 seem over-cautious. In addition, the declines in international food prices provide the option of augmenting domestic supplies and contain future prices. To pursue this reasoning, we refer to the recent RBI working paper, “Analytics of Food Inflation in India” (October 2014), which shows the food inflation persistence in recent years is largely attributable to higher rural wages, minimum support price increases for rice and wheat and rise in agriculture input costs. How are these three drivers unfolding as we step into year 2015?
Recent data clearly shows a sharp deceleration in rural wage rate growth in the last two years, or a marked weakening of a key driver of food inflation. Will the trend reverse as aggregate demand accelerates, since GDP growth is projected to rise to 5.5% in 2014-15 and further above 6% in 2015-16? The answer would depend on both the pace of demand acceleration and its sectoral composition. At this point of time, growth projections appear a little optimistic given the weak credit demand, investment activity and exports, apart from contractionary monetary-fiscal policies and strained public revenues.
In the event that aggregate demand accelerates, albeit at a slower pace, this would most likely be driven by services, mining and power segments, which do not create much demand for rural labour. Slow growth in manufacturing and construction activities, e.g., housing, real estate and infrastructure, signifies that demand for labour in both rural and urban segments will continue to remain subdued. This indicates that the considerable current slack in rural labour employment should mostly offset any possibility of wages’ acceleration in the near future, or at least until growth becomes broad-based.
Earlier we had argued how rural consumption demand is facing severe headwinds (The Financial Express, December 24, 2014, “Rural demand headwinds”, goo.gl/aDiqkI) from public-spending cuts, lower farm prices and slowing remittances—evidence suggesting severe compression of demand for food by rural households who allocate a larger income portion to these items. On the other hand, higher demand concentrated in services’ activities, i.e., mostly urban and semi-urban segments—also suggests that demand for non-protein foods will be weak as these households allocate relatively lower expenditure shares for these things.
Next, while agriculture input costs are expected to benefit from the fortuitous movements of global oil and fertilizer prices, it needs to be underscored that the RBI study finds the impact of MGNREGA on food inflation is not sustained. With spending on this programme sharply cut in the current budget, this driver has weakened even more. Topping these waning impulses is the moderation in MSP increases for rice and wheat in the last two years; the more notable feature here is the recent advisory by the central government that states refrain from paying additional bonuses that earlier seemed to have compounded food price increases. Future MSP hikes can reasonably be expected to be dampened as domestic prices converge to those internationally.
The above analysis suggests the three key drivers of food inflation should remain tempered, at least in the near-term. A base-line, normal monsoon scenario would therefore suggest that any sharp reversal in food prices should be a low probability outcome in 2015-16. Benign international food prices would additionally benefit the food economy in the event domestic conditions falter from monsoon uncertainties. Indeed, the latter could already be playing a signalling role in slowing down domestic food prices.
Recent developments in wheat prices are a good illustration in this regard. It is commonly understood that the government decision for open-market sales of 100 lakh tonnes of wheat from its ample stocks has restrained wheat prices. To the contrary, as the table shows, actual sales have been a paltry 12.66 lakh tonnes, much lower than the 62 lakh tonnes of open market sales in 2013-14 and 69 lakh tonnes in 2012-13. Why have bulk consumers and private traders, who normally buy from these open market sales, shied away? Does this indicate lower domestic demand? Or does it signal private traders’ expectations about future direction of prices? It can’t be a mere coincidence that international wheat prices have crashed 25% in October 2014.
A similar impact can also be observed in some non-food items like cotton (primary articles) where international prices have fallen below domestic prices, hurting exports and triggering imports. Consequently, Cotton Corporation of India (CCI) is left with no choice but to build up carry stocks, which will then push down future domestic prices. The situation will be no different for FCI, which will be carrying more wheat stocks than it intended, impacting future wheat prices in turn.
Prospects for other foods like rice, pulses and coarse cereals also cannot be very different as current global conditions are characterised by ‘abundant supplies and less uncertainty,’ as reflected in the fall of FAO’s food price index to a four-year low. This should also signal that if policy space remains opens to liberal imports to augment domestic supplies, future food prices could certainly be kept under check, with a few exceptions of protein foods where supply constraints persist.
The author is a New Delhi-based macroeconomist