More on India's volatile inflation story

For more than a year now, India has been grappling with high inflation, especially in foodstuffs, even as most other emerging economies had stable inflation rates. Now however, with steadily rising petroleum prices, food and oil inflation is fast becoming a global worry. There is therefore the added worry that rising global commodity prices will spill-over into India and amplify inflationary pressures.





An extraordinary confluence of bad weather across many exporting countries have affected supply of many agricultural commodities crops and the resultant supply-constraints might help keep prices high over the next several months. However, unlike the steep food price spikes of 2007-08, there are adequate global supplies of grains like rice and wheat, and their prices too are much below those peaks. The supplies of sugar, meat and oils remain close to their highs.

Further, there is strong enough evidence in favor of more structural-demographic factors for India's food inflation. The rising per-capita incomes are naturally accompanied by shifting consumption patterns. People increase their consumption of high-protein meats and pulses, oils, vegetables and fruits.

It may therefore be no coincidence that the prices increases have been steepest in these categories. At a compounded annual growth rate (CAGR), the price of a basket of vegetables has increased 21.26% in the last five years, compared to the WPI for all commodities rising by around 5%. In simple terms, the increased supply (and the acreage, production and productivity of vegetables have risen) has not been able to keep pace with the increase in demand.

In this context, it is also important to bear in mind the specific nature of inflation in India. Deepak Mohanty's excellent speech which examined nine instances of long-enough double digit inflation episodes since independence, describes India a "moderate inflation country". Further, though inflation trend has been downward sloping, it has been characterized by the sharp volatility. This volatility, especially in food and fuel inflation, can be attributed to supply-constraints. The Free Exchange has an excellent summary of India's volatile inflation path,

"So rather than call India a persistently high-inflation economy, it may be better to think of it as a country where inflation is relatively more volatile through the business cycle than in other countries... It doesn’t help that Indian agricultural output is very volatile, partly because of poor infrastructure, bad supply chains, poor storage facilities, and the like. This means that changes in weather conditions or other factors affecting output can lead to really large price fluctuations."

The wholesale price inflation always lags behind the consumer price inflation, with its greater focus on food and fuel prices. In fact, as the graphic below indicates, the relative weights attached to food and fuels in the consumer price index basket is amongst the highest for India. This too contributes to the abnormally high recorded rates of inflation for India.



Pressure is mounting on the Reserve Bank to rein in rising inflation by raising interest rates. However, as the aforementioned factors indicate, merely tinkering with monetary base when the supply-side constraints are driving inflation may not yield the desired results. Rapid expansion in supply - especially those of vegetables, fruits, sugar, pulses and oils - is the only sustainable way to address inflationary pressures in India. Monetary policy actions can, at best, contain core inflation and prevent food inflation spilling over into the rest of the economy.

Finally, as I had blogged earlier, it will be intriguing to find out the contribution of NREGA to higher food prices in India. There are two clear channels through which higher NREGA wages could spill-over into the price system. One, higher NREGA wages increases the cost of production by bidding up farm wages. And this impact could be susbtantial, given the fact that NREGA wages are more than double the prevailing agriculture labor wages in atleast some states. Second, higher NREGA wages places greater disposable incomes in the hands of rural consumers, which increases the demand for the higher value foods. The near universal nature of NREGA means that the demand-side pressures are substantial.

Update 1 (8/2/2011)

After a record heat wave and drought in Russia last summer, which pushed Moscow temperatures above 100 degrees for the first time ever (half the global decline in wheat production has been in Russia); dry weather in Brazil; and biblical-proportion flooding in Australia in November-December 2010, here comes more trouble from China. A severe drought, the driest winter in 60 years, is threatening the wheat crop in China, the world’s largest wheat producer.

The FAO has said that 5.16 million hectares, or 12.75 million acres, of China’s 14 million hectares of wheat fields had been affected by the drought, and that 2.57 million people and 2.79 million head of livestock faced shortages of drinking water. However, China had about 55 million tons of wheat in stockpiles as of last summer, equal to about half the annual harvest. It is self-sufficient in most foodgrains, and imports only soyabean and corn, mainly for animal feed (as the Chinese diet shifts towards meat)

See this on rising food prices across the world since last summer due to declining production. Paul Krugman sees no signs of any speculation, as manifested in inventory build-up.