Saturday, 14 June 2014

Why are food prices rising unabated? What can we do about it?

This is the transcript of an interview given for the forthcoming issue of CII's Economy Matters:

Why are the food prices rising unabated despite several measures taken by the government?

Firstly, let's set the context correctly. The government has an unenviable task of walking a tightrope between the diametrically opposite expectations of the farmers for higher prices and the consumers for lower prices. Given that the majority of our farmers are small and resource-poor, and the consumers are largely low or middle-income, the government cannot short-change either constituency for the sake of the other.

In this backdrop, let’s recount the key actions taken by the governments from time to time, and the limitations of such actions, because of which the prices continue to rise.
When the objective is to balance conflicting interests, any government’s first strategy is to subsidise. Subsidies on inputs like water, power, credit, and fertiliser to keep the cost of production low; and then subsidies on food itself by buying at high support prices from the farmers and selling at lower prices to the poor consumers through the public distribution system. No doubt, subsidies have delivered the expectations to a large extent. But, given the fiscal position of the government, this strategy is neither scalable nor sustainable beyond a point. Once that point is reached, as we have now, the subsidies strategy leaves both the farmers and the consumers dissatisfied despite consuming massive amounts of money. Additionally, the resultant market distortion discourages the private investment in the sector, and the value chains remain under-developed.

Another strategy that's adopted is to import food products, or ban the exports in times of shortage. Given the fleeting speed at which the international commodity markets move, our responses are often too late. The problem is further compounded by the weak market intelligence system the governments typically have, and the complex logistics of the global trade. In times of shortages, expectedly, the domestic prices are sky-high while the crops are standing in the fields, raising the price expectations of the farmers; then the import consignments usually arrive just about the time the farmers are ready to harvest their crops, and the prices start falling like there is no bottom!
Imposing stock limits to prevent hoarding of farm produce is yet another measure that's commonly used to control prices. This action does soften the prices, but only temporarily. However, because this measure cannot actually increase the availability of food in the season as a whole, the prices do go up eventually. Besides, since the government doesn't distinguish between hoarders and the genuine Agri Businesses / Food Processors, such restraints render investments along the supply chain and processing unviable, and the value chain participants remain fragmented.

One can possibly refine these strategies a bit more, viz. sharper targeting of subsidies, proactive imports through real-time market intelligence etc., and keep the prices under check a few weeks longer. The longer-term food inflation cannot be truly tamed unless the key drivers are appreciated and managed. 
What according to you are the key drivers of food inflation?

While quite a few reasons have been cited for triggering food inflation, demand outpacing supply is definitely the key cause, to my mind. Increasing incomes and changing lifestyles & aspirations have spurred the demand for food items, especially high value products such as fruits, vegetables, milk and milk products, eggs, fish, and meat. Per capita consumption of many of these products in India is still significantly below that of comparable countries, suggesting the likelihood of this trend continuing in the years to come. Given this scenario, it is crucial that the supply rises substantially to meet the rapidly expanding demand for food.

That brings us to supply side drivers. Though farm yields in India have grown significantly over years, they are still largely dependent on the annual monsoon rains and other vagaries of weather. In certain crops like vegetables that are more vulnerable, adverse weather conditions result in serious damages, leading to exorbitant prices for a few months almost every year in some corner of the country. Rising Minimum Support Prices for certain key commodities, especially wheat and rice, have pushed the prices of those crops up. With the introduction of the Mahatma Gandhi National Rural Employment Guarantee Act, agricultural wages have risen as a result of labour shortage, contributing to rising costs of production. Then there are chronic supply chain deficiencies (high transaction costs due to long chains, huge wastages due to broken chains, increasing cost of transportation due to rising fuel costs) that don’t let a fair share of the consumer price flow back to the producer. The supply chain deficiencies also prevent the demand signals from flowing seamlessly to the farmer. In the absence of such a mechanism, most farmers produce crops based on the prices obtained for the previous crop rather than the prices expected for the crops being planted. This results in huge price swings due to supply-demand imbalances around the harvest time.

As a combined effect of all these complex factors, the food prices in India kept moving up since 2007 when supplies fell short of demand globally; all that the various price control measures achieved was temporary respite from time to time. In these seven years, prices of cereals rose unabated, at an average of 10% per annum; the vegetables also started at a similar rate of 10% per annum, but accelerated to an average annual rise of 30% in the more recent years.

More broad-based reforms in the agricultural policy framework, together with the creation of certain market based institutions and instruments only can deal with these complex factors and solve the problem of food inflation in the long run. Otherwise, one would have to fire-fight every few months to deal with the crisis.

What are those reforms, which can really contain food inflation in India?

There are four areas of intervention that will make a difference:

Reforming the APMC Act along the lines of new Model Act recommended by the central government in 2003 is the first step. The alternative marketing models envisaged in the Model Act, viz. Direct Marketing, Contract Farming, and Private Mandis will provide a healthy competition to the conventional Mandis and offer a choice to the farmer. These models will be customised to different contexts, eliminating the non value adding transaction costs that came into being only because the conventional Mandi was mandated as the only mechanism for a farmer to market his produce. APMC reform will also help in changing the purely transaction oriented relation between an Agri business / Food Processor and the farmer in a Mandi set up, to a reciprocally dependent partnership. This will motivate Businesses to engage with farmers to raise farm productivity and align crop quality to consumer demand in mutual interest. This will also lead to complementary investments in storage and handling infrastructure along the supply chain that reduces wastage.

Secondly, the Forward Contracts Regulation Act (FCRA) must be amended to permit trading in ‘Options’. Farmers will then be assured of a minimum price at the time of sowing itself, based on the future projections of demand simulated by a market consensus. This will help adjust the production volumes to the future demand conditions, thus minimising the potential shortages as well as avoidable wastages, and the consequent price volatility.

Solutions like crop and weather insurance are also essential to enhance the risk-taking capability of the farmer, who can then invest in the required technology and inputs to step up productivity.
Lastly, the protocols for approving new technology must be scientific, made transparent and predictable to attract investments into R&D. We have some distance to cover in discovering seeds that will optimize drought tolerance, disease resistance, yield enhancement, pest resistance, enable nutritional enhancement etc.

You mentioned Food Processing briefly. Can it play an important role in dealing with food inflation?

Anywhere from 5% to 40% of food is wasted along the chain, depending on the inherent perishability of the crop and the season. This obviously reduces the actual availability of food even after the farmers have produced. Food Processing offers a solution to reduce this colossal wastage and contain inflation.

India processes just about 2% of its agri-based products compared to other developing countries such as Malaysia and Thailand who process as much as 40 %. A key constraint for the growth of the sector is the high prices of processed food, primarily because of the cascading effect of taxation along the value chain. Consequently, consumption of processed food remains low despite rising disposable incomes, adversely impacting the investments in this very important sector.

Full potential of this sector can be exploited if processed food products are made affordable at lower prices through a zero-tax regime. Such a tax regime must be extended for a minimum period of 5 years to communicate stability and attract investment.

With the prediction of a deficit monsoon this year due to El Nino, do you see food inflation going out of bounds soon?

Just as El Nino was showing signs of weakening, a monsoon blocker developed in Indian Ocean! It is certainly a situation that requires close monitoring. More important than the overall deficit in rainfall, is its spacial and temporal distribution. There is insufficient visibility on that count at this time. We therefore need to be prepared with contingent plans for different micro-regions, to be able to rapidly deploy them as the situation evolves. A big comfort, of course, is the large stock of wheat and rice available with the government. So, if at all something goes out of bounds, it would only be a vegetable here or a fruit there…

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