No convincing explanation emerged for their continuous, steep fall. A tentative Proposition is there may be an explanation in Friedman’s Permanent Income hypothesis.
Without doubt, the biggest macro puzzle of 2018 is what exactly is driving down food prices. Food inflation tumbled from 4.7% at the year’s start to -2.6% by November; at 137.8, CPI-food was below July 2017 level (138.3). Startling anomalies arose, upsetting inflation forecasts and historically familiar policy outcomes—a widely expected price boost from higher MSPs not only failed to materialise, but market prices actually sank below the official floor! Many explanations surfaced, examining the depression in food prices from supply as well as demand perspectives. But, none precisely conforms to the data. The year ends with the unresolved question carrying over to 2019. As fits the occasion, a brief dissection is accompanied by a new, tentative hypothesis for trial in 2019.
The dominant narratives on the collapse in food prices were supply-side ones. One driver singled out was the government’s proactive food-supply management through procurement, imports, stocking, open market sales and public distribution, export restrictions, stock-holding and inter-state movement limits, anti-hoarding raids and extensive price interventions. But, these weren’t enduring enough for the broad-based, deepening price decline, except for pulses where a series of mistimed interventions (high import volumes coinciding with MSP incentives resulting in higher output and stocks) played a key role. Next is the excess production supposition due to increased productivity, rural infrastructure investments, and better access to markets, information and technologies. But agriculture production and yields data does not support these explanations.
Annual average growth of food crop volumes, including high-value horticulture crops, has been way lower in the four years to 2017-18 compared to corresponding growth measures in the previous four years (2010-11 to 2013-14) with the sole exception of milk. Neither do the data betray exceptional productivity increases in any major food crop or horticulture. Yields appear to vary with rainfall and its distribution over the years. This incontrovertible evidence on output and yields led us to examine if demand factors explained the persistence of abysmally low food prices (FE, June 2018). Aggregate private final consumption demand grew a strong 7% on average from 2014-15 to 2017-18. But this robust domestic demand seemed unable to support food prices, despite accounting for some imports and weakening global food prices from 2013. This led us to speculate if private consumer spending was overestimated, or income growth skewed towards urban segment while the rural component lagged behind given steadily decelerating rural wages after 2014 and sustained weakness of labour-intensive segments observed from their strained finances, and even possible diversions of housing, MUDRA and other retail loans’ diversions to vehicle/tractor purchases.
But in 3Q2018, FMCG sales accelerated with broad-based strength, including home-care & personal products. Core inflation remained firm at 5-6% and even more sometimes in the period, especially health and education components. On the other hand, momentum in consumer goods’ growth (durables & non-durables) fell off its March 2018 peaks. And further complicating this mixed picture of demand strength, food inflation tumbled in 2H2018, turning into deflation by October!
The puzzle about what’s dragging down food prices only deepened. The contrarian trends here and there leave us no wiser at the end of the year. Even RBI is puzzled, uncertain about portents for its outlook in the medium-term and wants to understand better the drivers of food inflation as revealed from its December meeting minutes.
2019 begins with the puzzle unresolved. The unclear trends pose two questions: Has spending on certain goods and services become essential for the neo-poor (people whose income and consumption rose sharply in the past decade and half) in both rural and urban India? If yes, is this group continuing to spend on these items but reducing its overall food consumption as per capita income growth fell in the last two years?
A tentative hypothesis is worth examining in 2019 for answers. With reference to Milton Friedman’s permanent-income hypothesis (1957), consider the income-consumption trajectory of the average Indian consumer: Incomes rose rapidly in the post-2004 growth boom—8% average in FY06 to FY08 and 7.2% to FY11—and poverty declined sharply in the period. Consumption shifts towards more and better foods such as vegetables, fruits and protein-rich items were observed, followed by increase in demand for some consumer non-durable goods and services such as education, communications, health, etc. which no doubt became essential spending for many of these new consumers. Per capita income growth slowed in 2011-13, but resumed climbing to 6.8% by FY16; it then fell a steep 100 bps to 5.8% in FY17, decelerating to 5.3% in FY18.
Two consecutive years of falling incomes will possibly be seen as temporary by the marginal consumer whose spending pattern changed with the past upward shift in permanent income. She is thus likely to maintain her standard of living (uphold aspirational expenses) because she expects her income to restore to normal or permanent level in future. This is the central idea underlying Friedman’s permanent-income hypothesis—increases/decreases in income that people view as temporary have little effect on their consumption spending; on average, people base their idea of normal or permanent income on what happened over the past several years and attempt to retain consumption, including by dis-saving.
Some of these forces might be at play in India as spending on non-food goods and services, which entered the consumption basket with higher income levels, is perhaps being sustained. This could be through cutting food consumption and/or by dis-saving. Aggregate household savings have fallen while some consumers are eating less better foods than before to maintain their living standards. School enrolments and education premium rose with higher incomes for example, and education expenses are likely to be incurred even when income growth slows for its improbable that children will be withdrawn from school or prevented from entering higher education if households perceive their income decline as temporary. Similarly, recently acquired tastes and preferences for personal products, communication goods and services also attain the characteristics of ‘essential’ or ‘necessary’ spending. Empirical support for this speculation, in addition to the sustained inflation seen in these categories (core inflation), is offered by surveys of consumers expectations. These consistently show high consumer optimism about the future even when the current perceptions remain lower. RBI’s survey of consumer perceptions and expectations on spending reveals the discrete jump of September-2014 persists at those levels even as consumers’ worries on jobs and the economy have fallen back to pre-Sept 2014 levels.
This is still a tentative hypothesis which can only be validated by future NSSO consumption expenditure surveys. However, if this proposition holds, then food consumption should gradually return to normal when expectations improve in consonance with optimism about the future. Along with, food prices should then recover in 2019. On the contrary, if current expectations continue to remain lower or further deteriorate, then consumers would begin to cut on their other expenses, thus dragging core inflation down.
(The author is Delhi-based macroeconomist)