|Tuesday, 19 June 2012 00:11|
Since FY05, prices of protein sources in WPI have by 113% as compared to 59% for all other goods
Given that inflation is generally seen as a pure monetary phenomenon, it’s not surprising the usual suspects have praised RBI for not cutting policy rates, for not being soft on inflation. Not only is generalised inflation high, the argument goes, the suppressed inflationary potential remains high from required hikes in diesel and power tariffs for instance—indeed, thanks to last week’s sharp hikes in minimum support prices, 15-16% for rice, 33% for edible oilseeds, 30% for pulses and 53% for coarse grains, another inflationary spiral is waiting to happen (using data from 1978 to 2011, Surjit Bhalla shows a 10% hike in procurement prices leads to a 3% hike in CPI).
But given inflation remains reasonably robust despite the huge collapse in GDP, significant reduction in crude oil prices and a money supply growth that’s below even what RBI has been forecasting, this suggests supply-side factors need to be addressed to control inflation, and that rate cuts are of limited use. It’s another matter that a rate cut would probably stimulate investment, and GDP growth, but more of that another day—this column is about why interest rates alone can’t control inflation.
An interesting note, in this context, is that from BNP Paribas’s economics research team. “India: The Chips Are Not Down” sounds like a reiteration of the government’s anti-S&P tirade (and now, anti-Fitch tirade!) that the Indian economy has a lot going for it, but is actually about the humble potato (as in chips!) and other vegetables and the havoc they’re creating in inflation.
Since FY05, BNP Paribas economists Richard Iley, Dominic Bryant and Mole Hau say—justifying the point made by RBI deputy governor Subir Gokarn—prices of protein sources in the WPI have risen by a whopping 113% while everything else in the WPI basket rose just 59%. And since agricultural productivity has remained largely stagnant in this area, India’s imports of both pulses and milk have risen. What makes things worse, in the case of pulses—in the past 8 years, pulses-WPI has averaged around 12%—where Indian yields are a fraction of global yields, is that just 16% of all pulse crops are on irrigated land (it’s 4.5% in the case of arhar), leaving the crop very dependent upon the monsoon.
Or take fruits and vegetables that have a 3.8% share in the overall WPI and are really the big contributors to the current inflation problem—while protein sources have risen steadily, they’ve paled in comparison in recent months. After falling 34% in December 2011 and 44% in January, vegetable prices rose 33% in March, 61% in April and 49% in May. BNP economists point out fruits and vegetables rose 179% on an annualised basis in the three months to April—this follows an annualised deflation of 38% in the three months to January and a 183% annualised inflation in the three months to January 2011!
And much of this volatility came from potatoes which rose around 68% in May (chips are up!), 53% in April and 18% in March—they fell 2% in February, 23% in January and 35% in December 2011. Huge hikes in prices encourage farmers to plant more potatoes; in the absence of adequate cold storage, the glut causes prices to crash; this then drives farmers away, and prices spiral. While potato prices rose 773% on an annualised basis in the three months till April, the sharp volatility in fruit and vegetable prices is truly worrying.
While greater investments in cold storages are in themselves not related to FDI in retail, the fact is that once potential back-end cold storage (and transport) vendors are assured of regular and large retail buyers such as Wal-Mart, they will come in and invest. Which is why, now that Mamata Banerjee has been decimated (the biggest advantage of Pranab Mukherjee moving to the President’s job!), the government would do well to move rapidly on policies like FDI in retail—along with allowing foreign airlines in aviation, it would also do wonders for the investment climate.
One more interesting point is of the structural break when protein-WPI became more important. The timing, says BNP, is around the same time that spending on social programmes such as MGNREGA picked up—in other words, higher income in rural areas, a good thing in itself, when matched with a static protein output, has been a significant reason for the current bout of inflation.
So, whatever else RBI’s policy may or may not do, if the government is serious about inflation control, it has to carry out large agriculture reforms. Not having free agriculture markets (a state subject, not the central government) has meant that, on average, the ratio of food-WPI to food-CPI is more than 100% (see chart 4), with the situation getting worse in the last few years. FDI in retail, believe it or not, is actually an agriculture reform and is just one of the many that need to be worked upon—at a larger level, you can’t have a situation where subsidies are four times the government spending on agriculture investment.