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Although the RBI didn’t announce a rate cut at its second bi-monthly policy review yesterday, its tone was dovish. Whether it will cut interest rates sometime this fiscal in order to crank up the economy depends on how overall inflation, particularly food inflation, behaves.
India’s GDP growth was below 5 per cent in the eight quarters leading up to March 2014, but consumer price index (CPI) inflation has been sticky at around twice that (10 per cent). Clearly, inflation is not the byproduct of excessive demand or growth alone. To be sure, we are not in stagflation territory because the economy continues to grow. But high inflation in a slowing economy does generate stagflation-like concerns and makes the RBI’s task that much more difficult.
While GDP growth remained below 5 per cent in the fourth quarter of 2013-14, retail inflation offered some respite as it declined to 8 per cent in February. And after a long time, wholesale price index (WPI) inflation too was under 5 per cent.
Taking the cue, the RBI pushed the pause button on rate hikes in April.
But, at least for now, the weakness in domestic demand persists. Industrial production data disappointed yet again, declining 0.5 per cent in March. The respite from price rise too may be transient — CPI inflation spiked again to 8.3 per cent in March and 8.6 per cent in April. This resurgence was led by inflation in vegetables, fruit, milk and milk products.
The threat of a poor monsoon due to the increasing odds of El Nino further complicates matters for the RBI. The Indian Meteorological Department now estimates there is a 60 per cent chance of the phenomenon playing out this year, thereby raising the probability of a deficient monsoon.
If the rains indeed turn out to be below normal, we will be back to square one — growth will retreat as inflation accelerates. This is the last thing we need when manufacturing is barely growing and service sector growth is decelerating. In the event, India’s growth would be around 5.2 per cent this fiscal rather than Crisil’s predicted 6 per cent, and the RBI will be forced to become hawkish.
Unreliable monsoons are a risk we have to manage and mitigate on an ongoing basis. But the bigger question is: is entrenched and elevated food inflation the new normal? That food inflation spikes even when monsoons are normal supports this thesis. Researchers at Crisil have found that the drivers of food inflation seem random: vegetables and fruit in 2012-13, oils and fats in 2011-12, condiments and spices in 2010-11, pulses in 2009-10, cereals and pulses in 2008-09, and oils and fats again in 2007-08. High, double-digit inflation has been observed in more than one food category every year.
In addition, within food products, protein (milk, eggs, meat and fish) inflation has been stubbornly high as supply struggles to catch up with demand. The sharp rise in rural wages and increasing incomes have created demand for these items, while little has been done to create conditions to improve supply. The consequence is high and sticky protein inflation.
If the current low growth-high inflation nexus continues, incomes will not rise fast enough, while the purchasing power of consumers will keep getting eroded, particularly of those whose wages are not indexed to inflation. The current milieu has already sheared financial savings as households have shown a preference for physical assets such as gold and housing. Apart from macroeconomic instability, high inflation is also a tax on the poor.
The task before the new government is thus clearly laid out. In addition to reviving business sentiment and growth, it needs to have a concrete plan to bring inflation, particularly food inflation, down structurally and curb its volatility. And apart from closely monitoring the monsoon and preparing a contingency plan to deal with its failure, certain steps need to be taken to curb food inflation.
First, the timely and effective use of food stocks can help dent inflation. The inability of the government to intervene on time by releasing grain stocks has led to the persistence of high inflation even in cereals such as rice and wheat, which are overflowing in FCI warehouses. Rice inflation was 12.6 per cent and wheat 6.3 per cent in March 2014, whereas their stocks far exceed buffer norms.
Second, improving storage and logistics for perishables, and revoking the APMC acts is critical. Vegetable inflation has shown rising volatility over time with each peak higher than the one before it. The wastage of fruit and vegetables is estimated as being around one-third of production by Crisil. While Icrier notes that 15-25 per cent of total produce sold is wasted due to the multiple intermediaries and poor mandi infrastructure, perpetuated by the APMC acts. The dismantling of APMCs will promote efficient markets in the agriculture sector and trigger investments in logistics, thereby benefiting both farmers and consumers. However, this will need to be complemented with government efforts to improve rural infrastructure connecting farmers with robust agricultural markets.
Third, the improvement of supply response is the order of the day. Three things will need to be done for this. Improving agricultural productivity will be a long-drawn project and will require a mix of better irrigation, improved seed variety, the diffusion of technology to farmers and the judicious use of fertilisers. China produces twice the amount of rice, 1.5 times more wheat and 3.5 times more coarse cereals per unit of land than we do. We desperately need to catch up with them.
Crop diversification with a focus on fruit and vegetables is also important. The government needs to exercise restraint on minimum support price increases. The sharp increase in the MSP for cereals has resulted in excess cultivation and unmanageable stocks, which involve huge carrying costs. This has not only discouraged the cultivation of fruit and vegetables, it has also created an artificial floor on food inflation and has led to the excessive use of scarce groundwater. Last, the government must take steps to improve supplies of milk and other animal proteins. This is vital as food habits are changing, and a growing population and rising income means demand will continue to increase.
It is not possible to reduce food inflation in a hurry but once concrete and credible steps are in place, it will begin to soften structurally, and overall inflationary expectations will also mellow. “Everything can wait, but not agriculture,” Jawaharlal Nehru had said after India attained independence. The statement is as valid 65 years later.
The writer is chief economist, Crisil