The Indian government has shown just how inept, illiberal and devoid of all logic its strategy to combat inflation really is. The government’s decision last week to suspend futures trading in potatoes, chickpeas, rubber and soya bean oil didn’t come as a huge surprise; it was, nonetheless, a big disappointment.
There doesn’t seem to be a compelling reason for the government to take such a heavy-handed step for products that together account for less than 1% of the inflation index. And even if one accepts at face value the government’s claim that it’s trying to cool speculative fever in essential items, one can’t fathom why its wrath had to fall on the humble spud: The spot price of potatoes has declined 27% this year, according to Multi Commodity Exchange of India Ltd., one of the bourses where contracts on the produce were traded.
The expansion of the ban on agricultural commodities—contracts in rice, wheat and lentils were halted last year—was all the more egregious because the government had no justification for taking such a step. It had set up a committee to investigate whether futures trading in commodities had amplified price volatility.
The panel, which submitted its report last month, didn’t find any evidence to settle that question one way or the other. Yet the government went ahead with its decision and halted trading for at least four months.
With the annual inflation rate at 7.6%, the highest in three-and-a-half years, the government is desperate for solutions. But steps such as prohibiting exports of agricultural goods or thwarting their domestic price-discovery by scrapping futures do more harm than good. What’s destroyed in the process of suppressing free markets is often invisible but is nonetheless extremely valuable.
Take potatoes. The futures were starting to gain popularity among large retail chains that were using the contracts to take delivery of good-quality produce that had been stored well. This could have potentially had a very large benefit.
In India, the bulk of the potato crop is harvested between January and March, just before the onset of the summer months. If the crop is left on the farm, in so-called rustic storage, a fifth of it goes bad within 90 days. It’s a dead loss to the grower.
And yet, in the absence of futures trading, the potatoes grown by small farmers in northern India didn’t often end up in proper warehouses. That’s because the farmer weighed the costs and benefits of cold storage against the unknown risk of a glut and the subsequent collapse in the future price of the commodity.
Nor did the cold storage have much incentive to chase the business of small growers: In the event the price of the potatoes held in storage crashed, these farmers might not even have money to pay for warehousing and reclaim their produce.
Contracts that allowed the future price to be locked today made storage a less risky proposition for both the farmer and the warehouse. That, in turn, held the promise of improving the economics of the cold-storage business, leading to more entrepreneurs investing in creating new capacity.
The ban on trading will disrupt this virtuous cycle, which was only beginning to make an impact and would have been strengthened with a law that aims to make warehouse receipts widely acceptable as collateral.
With the general election due to be held in the next 12 months, it’s very important for politicians to be seen to be doing something. It doesn’t matter how ineffective or counterproductive that “something” happens to be.
Prices of kerosene and liquefied petroleum gas, which are directly controlled by the government, haven’t been raised since April 2002 and November 2004, respectively. Nor has the government allowed refiners to pass on the full cost of record-high crude-oil prices to motorists.
None of this has come for free. The government has piled up substantial future liabilities in its bid to keep domestic prices of fuel, food and fertilizers affordable.
These so-called off-budget expenditures are now so large that adding them to the fiscal deficit of the federal and state governments would raise the latter to 9.3% of gross domestic product (GDP) in the year ending 31 March 2009, from an estimated 5.3% in the previous 12 months, according to Morgan Stanley economist Chetan Ahya in Singapore.
A budget deficit-to-GDP figure of 9.3% wouldn’t be very different from the 9.6% level of five years ago and would constrain the government’s ability to lift economic growth by boosting public spending should private investments slow down.
Controlling inflation doesn’t mean shielding people from having to face the true economic cost of their current consumption. Nor does it mean telling farmers what they can sell, when and to whom.
None of this really helps the domestic poor, whose interests could be much more efficiently safeguarded with transparent, well-targeted cash subsidies.
Designing such a mechanism takes a little bit of work; banning futures trading is as easy as it is weird.