High policy rates won't affect drought-induced inflation
Though we still have August to go through, it looks increasingly likely 2012 will be a drought year on par with 2009, if not slightly worse. Though the meteorological department is of the view that the rainfall deficit will “fill up in the coming days”, only the brave will put money on this. Agriculture minister Sharad Pawar used the dreaded D word on Thursday and the food minister has been talking of, if need be, banning futures in certain commodities to curb price fluctuations. The Met’s track record is quite poor—apart from lowering its 2012 forecast from 99% of the long period average (LPA) rainfall in April to 92% now, the Met spectacularly failed by predicting a normal 2009— but few other countries seem to be doing a better job in long-term forecasts, and the dramatic climate change is making nonsense of all modelling.
An analysis of the monsoon by rating agency Crisil juxtaposes the rain received so far with the irrigation availability in each state and finds that, with few exceptions like rice and sugarcane, the Deficient Rainfall Impact Parameter (DRIP) score is poorer than in 2009 for most crops. While Gujarat is the worst off state with a deficient rainfall of 82.3% so far, a lot depends on the level of irrigation facilities. Punjab is the next worse-off state with a 68.9% shortfall, but with 98% of its acreage irrigated as compared to Gujarat’s 46%, Punjab is almost unaffected with a DRIP score of 1.2 as compared to Gujarat’s 53.8 (the higher the DRIP, the worse off the state). Though a lot will depend on how the government’s anti-drought programme works—farmers are being advised to grow different crops and new seeds are being distributed and attempts are being made to distribute high-yielding varieties in states with low DRIP scores so as to increase production—it is likely there will be a price surge for a large number of crops.
There are obvious lessons here apart from the government being more pro-active in its anti-drought work—spending R4 on agricultural subsidies for every R1 spent on creating agricultural infrastructure like irrigation facilities is not just a waste of resources, farm incomes don’t rise as much as they do when agricultural investments pick up. The interesting question here is what lessons RBI will draw. Despite hiking interest rates dramatically, RBI hasn’t been able to control overall inflation—it has brought core inflation to comfortable levels—for the simple reason that interest rates have no role to play when the issue is one of huge supply constraints. Though the usual lot of finance professionals have made a case for keeping rates unchanged, so far none have suggested RBI raise policy rates to deal with the likely surge in food prices. Perhaps they should take their advice to its logical conclusion!