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Food Inflation: Contingent and Structural Factors

Food prices in the immediate future can be controlled only through large imports. Wheat stocks are adequate but rice stocks are not. There will be a fiscal cost because global prices are above domestic prices, but this will not be above 1 per cent of central government expenditure. This may be the best option since food inflation is now threatening to become generalised.

COMMENTARY

“ --” -” “ “” -" -” -"” ' -' ”

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and more sustained as compared with the

Food Inflation: Contingent and

Structural Factors
last episode of drought-induced supply shock in 2002-03. Foodgrain prices increased only by 3-4% in 2002-03 as compared to a rise of 12-15% in the current period. We highlight the specific condi-Rajiv Kumar, Pankaj Vashisht, Gunajit Kalita tions that are responsible for this steep

Food prices in the immediate future can be controlled only through large imports. Wheat stocks are adequate but rice stocks are not. There will be a fiscal cost because global prices are above domestic prices, but this will not be above 1 per cent of central government expenditure. This may be the best option since food inflation is now threatening to become generalised.

Rajiv Kumar (RKumar@icrier.res.in), Pankaj Vashisht (pankaj@icrier.res.in) and Gunajit Kalita (gkalita@icrier.res.in) are at the Indian Council for Research on International Economic Relations, New Delhi.

1 Introduction

T
he past two years have been challenging for the global economy not only because of the financial crisis but also because of the unprecedented volatility in world food prices. The first half of 2008 saw global food prices rising 41% over the previous year due to droughts and crop failures in several major food producing countries combined with a substantial diversion of foodgrains for ethanol production whose output increased by 32.3% in 2008 over 2007 in response to the steep hike in crude oil prices. However, there was a U-turn in the latter half of 2008, with global aggregate demand, including for foodgrains and fuel, declining sharply in the wake of the post-Lehman global recession.

While food prices in India rose in line with global trends, they did not follow the trend downwards.

and sustained increase in foodgrain prices and suggest some remedial measures.

2 Gap in Domestic Demand and Supply

The decline in rainfall during the 2009 monsoon not only caused a reduction in the net area sworn but has also adversely affected yields. Consequently, paddy and coarse cereals output is estimated to come down by more than 15% in 2009, compared to 2008. The production of sugar cane has declined by 9%. However, this decline is significantly less than the d ecline witnessed during 2002-03, when output of paddy and coarse cereals d eclined by more than 22%. Moreover, even in terms of per capita production of major agro-products, the current situation is far better than in 2002-03 (Figure 1). Hence, it is difficult to attribute the present price rise entirely to the drought.

Figure 1: Per Capita Production Index of Major Agricultural Products

In contrast, foodgrain

200

prices in India increased even more sharply from mid-2009 onwards. This has 100 largely been attributed to the drought and the resultant drop in kharif production. 0

Foodgrains Oil Seeds Per Capita GDP Sugar cane

1998-99 2000-01 2002-03 2004-05 2006-07 2008-09 2009-10

The price rise has

Source: Authors' estimates from Agriculture at a Glance, Department of Agriculture and been much sharper Cooperation and Handbook of Statistics on India Economy.

march 6, 2010 vol xlv no 10

EPW
Economic & Political Weekly

COMMENTARY

Figure 2: Domestic Demand and Supply of Cereals (million tonnes)

250
200
150
100
50
Source: Same as Figure 1. 2002-030 70 Figure 3: Foodstocks (million tonnes) 2006-07
60
50
40
30
20
10
0 1991 1993 1995 1997
164 173 167 203 202 187 196 196 200 Domestic Production Domestic Availability Domestic Demand

Source: Department of Food and Public Distribution. 2009-10

2002-03 and by 4 mt in the current period. A shortfall of an additional one million tonnes is not likely to cause the steep price increase being experienced now.

The feature that differentiates the two episodes is the level of cereals

Rice Wheat Total Stocks

Figure 4: Domestic Demand and Supply of Pulses (million tonnes)

25

20

15

10

5

0 2002-03Source: Same as Figure 1.

Based on the estimates of the 59th round of National Sample Survey Organisation (NSSO) of household consumer expenditure, and taking indirect demand for foodgrains into account, at about 17% of total demand,1 the total demand for cereals in 2003 can be estimated at around 167 million tonnes (mt). Following Bhalla (2001) and Mittal (2006) we use the expenditure elasticity of demand for cereals to project the demand for the current year. We make due adjustments to Mittal’s estimates for the higher GDP growth rate and also use different elasticities for rural and urban demand for cereals. This yields a total cereal demand in 2009-10 of 200 mt. From Figure 2 it is evident that production fell short of potential demand by 3 mt in

Economic & Political Weekly

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march 6, 2010

1999 2001 2003 2005 2006 2009 2010

Net Imports Domestic Production Net Domestic Availability Domestic Demand

2006-07 2009-10

stocks while going into the drought. In April 2002, just prior the drought, stocks were at their historically highest level of 63 mt (Figure 3). This stock not only worked as a disincentive for hoarding but was also used effectively by the government to augment market availability. In contrast, in July 2009, just prior to the recent drought, stocks were 52 mt, appreciably lower than in 2002. This led the government agencies to procure more actively and also appear to have restrained it from undertaking open market operations.

In the case of pulses, India has consistently faced shortages and its dependence on imports is well established (Figure 4). Though domestic production as well as the imports of pulses have consistently

vol xlv no 10

increased, they have fallen short of rising demand. Consequently, the gap between demand and supply has continuously increased from 1 mt in 2002-03 to 1.6 mt in 2009-10. The inability to raise the output of pulses over the past 10 years can be seen as one of the major policy failures in agriculture.

Following a decline in sugar cane production in 2007-08, domestic sugar production declined by 2 mt in 2008-09 over the previous year. Surprisingly, despite this production decline, sugar exports increased sharply in 2008-09. The decline in production along with larger exports reduced domestic availability, which fuelled inflation (Table 1). Consequently, sugar

Table 1: Domestic Demand and Supply of Sugar

(million tonnes)

Year Production Opening Exports Domestic Domestic
Stocks Supply Demand
2002-03 18.56 10.66 1.14 28.09 19.65
2006-07 19.26 4.83 1.37 22.73 27.17
2007-08 28.30 3.64 2.52 29.41 28.70
2008-09 26.34 9.20 5.85 29.68 31.40
2009-10 24.00 8.10 na 32.10 33.62

Source: CMIE and authors own projections.

prices started rising from May 2008 onwards. The monsoon failure further aggravated the situation. Given an absolute decline of 9% in production of sugar cane in 2009-10, domestic availability of sugar is expected to decline further and prices are likely to remain firm.

Hoarding combined with speculation is one of the main causes of surge in food prices. An abnormal difference between retail and wholesale prices can indicate the extent of hoarding. The gap between the two on account of logistics costs, margins and transactions costs is expected to remain constant over time with any sharp difference reflecting an increase in hoarding. The mark-up in retail prices over wholesale price went up from around 8% in December 2008 to 12% in December 2009

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COMMENTARY

Figure 5: Retail Price over Wholesale Price (%) prices remain 61% 4 Is Destocking an Option?

16 Rice

Wheat higher than the During an inflationary spiral, as is cur

domestic wholesale rently being experienced, the central pool

12

price. In the case of cereals can be used to reduce the supplyof wheat3 interna-demand mismatch. A minimum norm for

8

tional prices were buffer stock of cereals is set by the depart58% higher than ment of food and public distribution at

4

Groundnut Oil domestic whole-the beginning of each quarter. Figure 7 sale price in the shows that between 2005 and 2008, stocks first half of 2008, held in the central pool were below the

0 1993 1995 1997 1999 2001 2003 2005 2007 2009

but the gap virtu-buffer stock norms. To make up this defi-

Source: Ministry of Consumer Affairs, Food and Public Distribution, International Rice Research Institute.

ally closed by De-ciency the Food Corporation of India (FCI)

Figure 6: International Prices over Domestic Wholesale Prices (%)

cember 2009. made special efforts to procure additional

100

As indicated in quantities in 2009 which expectedly re

80 Wheat Rice Table 1, there was a sulted in a relative shortage of cereals in

60

surge in sugar ex-open markets, which in turn has pushed

40

ports during 2007-up prices.

20

08 and 2008-09. Table 2 reveals that in 2009-10 (April to

0

-20

Exports had dou-December), procurement of wheat was

Groundnut Oil

-40

bled each year 25.4 mt, nearly 8% above for the same

-60

during these two period last year when it was 22.9 mt. In

1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: Same as Figure 5. years. This rise in the kharif crop 22.9 mt of rice was proexports defies ex-cured. During 2009-10, when according to in case of rice. In comparison it had planation because unit value realisation4 the first advanced estimates, rice producincreased up to 14% in 2002-03! from exports, without taking the subsidy tion has declined by 15%, there has been a Similarly, for wheat, the retail mark-up available for exports, is lower than from 4% increase in the rice procurement. This over wholesale price was around 13% in selling in domestic markets.5 In a time has also contributed to rise in rice price in 2002-03 and in 2008-09 it is lower at 10%. when domestic production fell and available open markets. It seems that speculative activity and domestic price was higher than global The central pool stocks of wheat and hoarding is at least partially responsible for price, doubling of export for two successive rice were reported to be 47.4 mt at the end the presently high food prices (Figure 5). years is inexplicable and shows a rather of January-2010 with rice and wheat stocks ironical use of government subsidies. being 24.3 mt and 23.1 mt respectively.

3 International Prices

Figure 7: Actual Stock over Minimum Buffer Norms (%) Global food prices nearly doubled between 600

June 2007 and June 2008. They fell very

Wheat

sharply after that and were back to the 500 June 2007 level by February 2009. But 400 thereafter they have increased by almost an average of 12% between February 2009

300

and December 2009 across all food com-

Wheat + Rice

modities. The rise in agricultural raw ma-200 Rice

terials prices has been much sharper at 100 nearly 36% in the nine months between April and December 2009. 0

Figure 6 shows that in the case of rice,2

-100 despite a recent decline, international Source: Department of Food and Public Distribution – various annual reports.

Table 2: Offtake and Procurement of Wheat and Rice (million tonnes)

Assuming the offtake to remain constant

Offtake Procurement under Central Pool

as in the past months, 18 mt will be needed

Rice under Wheat under Other Welfare Open Total Rice Wheat Total TPDS TPDS Schemes Sales/ until November 2010, when the next rice

(Rice+Wheat)

Exports

procurement season will start. With a

2002-03 10.56 9.78 11.38 18.12 49.85 15.8 34.8

19.0

minimum buffer stock requirement for

2003-04 13.39 10.81 13.50 11.64 49.33 22.9 38.7

15.8

rice of 12.2 mt for the next quarter

2008-09 22.20 12.60 1.20 32.8 55.5

3.40 22.7

39.40

and obligations of the public distribution

2008-09 (April-December) 14.90 8.10 2.00 0.10 25.10 22.1 22.7 44.8

system and all welfare schemes, there

2009-10 (April-December) 18.10 14.40 2.90 0.50 35.90 22.9 25.4 48.3 Source: Department of Food and Public Distribution and Food Corporation of India. is simply not enough rice available for

18 march 6, 2010 vol xlv no 10 EPW Economic & Political Weekly

2001

2002

2001

2003

2004

2005

2006

2007

2008

2009

2010

COMMENTARY

open market sales. This perhaps explains the government's reluctance to push more rice into the open market and bring down prices.

For wheat the situation is different with a stock of 23.1 mt in January 2010 and next rabi procurement season starting in April. It is, therefore, quite inexplicable that the government had only conducted open market sales of 0.5 mt of rice and wheat together between April and December 2009 (Table 2, p 18). In sharp contrast, 10 mt of foodgrains were sold in the open market in 2002-03. While there is arguable limited substitutability between rice and wheat, selling available stocks of wheat would have presumably helped contain prices.

5 Conclusions and Policy Recommendations

The declining per capita availability of c ereals, pulses and oilseeds, referred to above, points to the need for focused policy attention on improving the state of Indian agriculture. Policy must be directed towards attracting more private investment, bringing in new technology and raising yields. The key would be to perhaps move away from the current system of subsidies and other government interventions that are evidently not achieving the desired results in securing food security and raising farmers’ incomes. We have to also consider extending the Mother Dairy model to cereals whereby the disadvantages of fragmented small-scale peasant production can be overcome by encouraging cooperatives or even private corporations to collect, process and distribute agro-products using the latest techno logies and modern practices. In short, the second green revolution needs to be ushered in urgently but on the basis of innovative thinking and not business as usual. But these are longterm concerns, while immediate steps are needed to bring down food prices as quickly as possible.

The structural reason for the food price rise seems to be the rising gap between per capita incomes, the resultant rise in demand for food products and the stagnant or declining per capita availability of these commodities. With rising incomes, the better-off have been successful in chasing prices to meet their demand, forcing the prices to rise and driving the poor to make do with lower consumption.

In the short term, greater amount of food products can be made available in the market by reducing post harvest losses and waste. This will be achieved by allowing the entry of private retailers who will modernise the supply chain for meeting their procurement requirements. Thus, while it may sound paradoxical, the second green revolution can start outside the agriculture sector by modernising the supply chains including logistics, warehousing and handling.6 But far more needs to happen. Private retailers who procure d irectly from the farmers offer them up to 30% higher farm gate prices and also in some cases help with the supply of new seeds and irrigation technologies, etc.7 Thus, the government will do well to encourage the entry of modern retail, both domestic and foreign, if it wants to modernise agriculture, raise yields and make greater supplies available in the markets. This will also cut the layers of intermediaries who currently appropriate a very large and disproportionate share of value addition and discourage private investment in agriculture.

In the more immediate context, food prices can be brought down and inflationary expectations weakened only by augmenting supplies through imports as e xisting rice stocks will not suffice to increase supplies in the market. With global prices already above domestic prices this will necessarily imply a fiscal cost. Taking all factors into account, it can be broadly estimated that importing 6 mt of rice will cost about Rs 6,000 crore or just above $1 billion. This works out to roughly 0.67% of total central government revenue expenditure in 2009-10. These can be augmented by releasing existing wheat stocks which will be replenished in April with the incoming rabi crop. This would appear to be a reasonable way forward to tackle food price inflation which is now threatening to become far more generalised and posing a threat to macroeconomic stability.

Notes

1 Courtesy estimates of Praduman Kumar (1998).

2 Five per cent broken, milled, fob Bangkok Rice.

3 Canadian No 1 Western Red Spring 13.5%, in store Thunder Bay, domestic, from 1985 St Lawrence export.

4 Total value of export divided by total quantity of export.

5 Sugar medium grade (Delhi).

6 This is already happening to a limited with chains procuring directly from the farmers and building a modern logistics and supply chain.

7 See Joseph and Soundararajan (2009) for details of the survey reports.

References

Bhalla, G S (2001): “Demand and Supply of Food and Feed Grains by 2020” in M D Asthana and Pedro Medrano (ed.), Towards Hunger-Free India (New Delhi: Manohar).

Joseph Mathew and Nirupama Soundararajan (2009): Retail in India, Academic Foundation.

Kumar, Praduman (1998): “Food Demand and Supply Projections for India”, Agricultural Economics Policy Paper 98-01, Indian Agricultural Research Institute, New Delhi, India.

Mittal, Surabhi (2006): “Structural Shift in Demand for Food: Projection 2020”, ICRIER Working P aper 184, ICRIER, New Delhi.

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