Persistence of high food inflation can harden the monetary policy stance and make fiscal choices difficult
Food inflation increased to 7.9% in May 2016 as against 4.23% in April. This sudden spurt in food inflation is attributed to vegetable prices, followed by pulses and sugar. Is this a short-term spike or will it be a persistent one? If it is going to be a persistent one with pass-through effects, its macroeconomic implications, especially for investment and growth, will be a matter of serious concern in FY17.
The political economy of food inflation is absolutely non-trivial in India due to its adverse distributional consequences. Should India look up to the monsoon, the central bank or the government to find a solution to soaring prices? Obviously, the solution primarily lies in the non-monetary policy space, and New Delhi is the centre of action. Let us look at the commitments made in Budget 2016-17. In February 2016, finance minister in his Budget speech announced that “Monitoring of prices of essential commodities is a key element of good governance. A number of measures have been taken to deal with the problem of abrupt increase in prices of pulses. Government has approved creation of buffer stock of pulses through procurement at Minimum Support Price and at market price through Price Stabilization Fund. This Fund has been provided with a corpus of R900 crore to support market interventions.” However, there is no clarity whether the price stabilisation fund (PSF) will be utilised and, if so, how? The high level Inter-Ministerial Meeting to contain food inflation happened a few days back, only ex-post to the spiraling of food inflation. Though the government has swung into action, and announced measures to contain spiraling of inflation, the point remains if ‘monitoring prices of essential commodities is a component of good governance’, the action should have started before the event has occurred. What spurted food inflation? Economists are divided on this. While a few scholars suggest changing cropping patterns as the culprit, and that India should grow more dal than sugarcane, a few others highlight rising rural wages due to MNREGA-infused liquidity into the system, and this ‘new money’ has had people demanding higher produce and turning their food budget more towards pulses. On the supply-side, weather-related variables—particularly unseasonal rain—too are blamed for unanticipated food inflation. The role of speculation and Minimum Support Price in triggering the inflation are also debated.
There are both short-term and long-term issues that must be addressed simultaneously by the government to tackle food inflation. Irrespective of the government in power, food inflation has become almost an annual event. The short-term measures should involve increasing supply of food items to meet the demand. Hypothetically, if demand-supply gap is not due to the rise in demand but due to the shortage of supply, increased supply should reduce the demand-supply imbalance and thereby price. The long-term measures require improvement in infrastructure to preserve perishable items like fruits and vegetables (though product switching from ‘fresh to frozen’ for affordability is only a second-best principle), a network of road infrastructure for better market-access and warehousing facilities. This requires a national strategy for both public investment in agricultural infrastructure and attracting private investment, wherever necessary and appropriate, to support this effort. It also needs to be recognised that when it comes to agriculture, 90% of public investment in agriculture is at the state level. As per the Indian Public Finance Statistics, in FY15, out of total public investment of R2,69,914 crore in agriculture, states’ contribution was more than 91% . Thus, it is important that a national strategy on agriculture should be undertaken, involving the Union and state governments. In this context, it also needs to be highlighted that gross capital formation in agriculture over the years has declined from 3.14% in FY12 to 2.52% in FY15.
Can good monsoons solve the problem? It is expected that after two years of consecutive drought, there will be full monsoon (more than 100% monsoon) this year. This need not necessarily result in corresponding increase in the supply of food items in the market automatically. The issue is long-term and structural, be it changed cropping patterns, infrastructural bottlenecks or market-access that the monsoon cannot alter. In the short run, the government should effectively deal with the issue of deficient supply, including effective intervention against hoarding. In this context, it needs to be noted that supply-side management issues cannot be addressed by monetary policy measures. As the finance minister has termed it as a “governance issue” in his Budget speech, hopefully, swift action will be taken to improve supply to bring down the prices.
Finally, what are the likely macroeconomic implications? If it is a short-term phenomenon without any pass-through effect, we need not worry too much about growth and investment. But persistence of high inflation can really harden the monetary policy stance and make fiscal choices difficult. High food inflation would be catastrophic for growth amidst the falling investment-GDP ratio. The new GDP estimates have infused altogether new reasoning for growth in India with stagnant capital formation, which is private-consumption led growth. As one is aware, since January 2015, repo rate has been reduced from 8% to 6.5%, possibility of further rate cut is ruled out at the moment. On the contrary, if inflationary pressures continue, in an extreme case, RBI could raise policy rates. If we consider the new monetary policy framework of inflation targeting, the average inflation rate is much higher than the Central Bank’s target of 5% by January 2017 and 4% in the next fiscal year. Impending Seventh Pay Commission award may put further inflationary pressure with more money in the hands of people. So the policy action and choices will have to balance supply and demand side management issues including higher public spending on infrastructure and rural development without incurring the risk of higher inflation, which is indeed a daunting task.