Inflation affects the purchasing power of people adversely. Especially food price inflation affects the poor and the low income groups harder than the higher income groups.
In India, the annual food price index rose by 10.6%, during the week ending October 8 compared to last year. Pushed by food prices the headline inflation has reached an alarming 9.72%. The latest hike in index is nearly double the rate that the Reserve Bank of India expects — annually 5% or 6%.
The inflationary pressure is not due to supply bottleneck in food grain. In fact, food grain production in India has reached a record 241 million tonnes in the agricultural year 2010-11, compared to 218 MT in 2009-10.
Food inflation has been a worldwide phenomenon since late 2008. The phenomenon is attributed to large scale diversion of crop land to biofuel production, loose money policy, fiscal imprudence and rise in fuel prices. Fuel price has indeed contributed to food price hike in India. But the other reasons do not apply to the Indian economy.
Deficit financing is on a leash. So is monetary policy. In order to tame the rising food price index, the RBI is trying to control money supply in the economy by raising repo rates, at which it lends to other banks, and reverse repo rates, at which it borrows from other banks. Already the RBI has hiked the repo rate by 3.25 percentage points in 12 installments since March 2010. This has jacked up the interest rate in commercial banks. High bank rate discourages investment and encourages savings, thereby reducing aggregate demand.
However, the increase in the interest rate has done little to contain food inflation. On the contrary, costlier loan has hampered the growth rates of Gross Domestic Product and industrial output in the current fiscal’s first quarter. According to the RBI, while industrial growth rate decelerated, agricultural growth rate accelerated in this period. Yet the food price index soared upward. This clearly is a failure of the country’s monetary policy or monetarism itself, endorsed by the International Monetary Fund.
Prof C Rangarajan rightly commented that increasing interest rates will reduce demand only in the housing and car markets. He does not envisage easing food inflation before the middle of 2012.
Rangarajan’s point is bolstered by the fact that the RBI’s tight money policy hardly has any impact on food price inflation. The failure of the monetary instrument in controlling inflation of basic food articles follows from exposing Indian agriculture to free market forces in many ways.
Unlike the industrial sector, the agricultural sector functions outside the organised money market. Farmers undertake production not for cash alone, but also for subsistence. Irrespective of monetary policy, agricultural production must take place.
Thus, farmers have to use costly fertilizer, pesticides, and irrigation to derive maximum yield.
The gradual reduction of state subsidy in fertilizer, pesticides and electricity for pump irrigation has escalated production cost. Deregulation of the petroleum sector, and allowing the oil PSUs to operate in a free market has imposed an additional price burden on farmers, as oil price keeps rising. Oil price hike, at double digit rates, results in higher transportation cost for agricultural commodities as also higher production cost for farmers using diesel pump sets for irrigation.
At the level of marketing and distribution of agricultural products, speculative commodity trading becomes active in influencing market prices. Futures trading and hedging in agricultural commodities can add to inflationary pressure. Prices of futures trading influence the spot market prices in commodity. A high price quoted in the futures market means a high spot price. In 2008, owing to high prices of potato, rubber and soy oil, the government had to ban commodity trading in these items, though with little effect.
As the government, at the behest of international financial institutions, is encouraging more of market economy and less of state role, the agricultural sector suffers due to the market’s vagaries. Traders and hoarders call the shots. The public distribution system is slack. Under such circumstances, the state’s distributional intervention was necessary but it stood aloof.
So much so that when wheat was rotting, the Supreme Court suggested that the excess wheat be distributed to the poor free of cost. The prime minister refused. Had the wheat been distributed free, the price of wheat in the market would have crashed. Just to prop up commodity trading and corporate retailers, the government fought the suggestion.
That is why only indirect measures like monetary policy is resorted to combat inflation.
The writer is a Kolkata-based economist, and a former member of faculty of Madras Institute of Development Studies, Chennai.