Inflation and the UPA policy mix

India needs to reform its food sector to keep farm prices high, retail prices low and control inflation
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First Published: Mon, Jan 21 2013. 10 22 AM IST
Prime Minister Manmohan Singh (centre) with Congress president Sonia Gandhi and Congress vice-president Rahul Gandhi in Jaipur on Saturday. Photo: PTI
Prime Minister Manmohan Singh (centre) with Congress president Sonia Gandhi and Congress vice-president Rahul Gandhi in Jaipur on Saturday. Photo: PTI
Updated: Mon, Jan 21 2013. 09 43 PM IST
Prime Minister Manmohan Singh has identified high inflation as the biggest failure of his government. He was speaking at the Congress strategy meeting at Jaipur over the weekend.
High inflation is the inevitable result of a peculiar policy mix that his government has pursued.
The latest inflation numbers released last week offer further evidence that India is failing in its fight against food inflation. Food prices have hovered around double digits for the better part of last year, and rose 11.2% in December. Food inflation is likely to rise in the coming months, raising inflationary expectations and core inflation numbers, wrote Sonal Varma and Aman Mohunta, economists at Nomura, in a 14 January note.
While seasonal factors may have contributed to the latest spike in food prices, India’s inflation problem has deeper roots. Few major economies have struggled to tame inflation as much as India has, in the past few years.
The structural roots of inflationary pressures in the economy lie in the pursuit of conflicting policy goals: one, of keeping retail food grain prices low to protect consumers and the other, of keeping procurement prices high to incentivize farmers. Apart from a massively wasteful distribution system, such a policy mix is self-defeating as it weighs down the government budget with a perennial subsidy burden and stokes inflation. This policy approach is not new, but it has become unsustainable during the term of the ruling United Progressive Alliance (UPA) coalition.
Unlike the famous impossible trinity in monetary economics, there is under-recognition of the impossible trinity of fiscal policy goals which handicaps the Indian state. It is impossible for India to attain the three goals of keeping farm prices high, retail prices low, and overall inflation under control, unless the food sector is radically reformed.
Successive increases in procurement prices over the past few years have directly contributed to food grain inflation because of the ineffectiveness of the state’s food distribution network. Rise in food grain prices also raised the demand for coarser grains and could have pushed up fodder prices, making protein-rich poultry products more expensive. There were indirect inflationary effects as well, as a bloated food subsidy bill widened the fiscal deficit. The difference between the economic costs of procuring rice and wheat and the prices at which they are distributed has ballooned over the past decade, wrote Ashok Gulati, economist and chairman of the committee for agricultural costs and prices (CACP) in a recent CACP working paper.
The way out of the impossible trinity lies in replacing subsidies with agricultural investments, which will raise productivity and farm incomes, without stoking inflation. But India seems headed in the opposite direction. Subsidies as a share of agricultural gross domestic product have risen sharply over the past decade and now account for roughly three-fourths of state spending on agriculture.
The mess will only worsen if the food security Bill is implemented in its current avatar as it is likely to entail an additional expenditure of Rs.6.82 trillion in the first three years, according to Gulati’s estimates. This will mean an annual tripling of the food subsidy budget. The inflationary consequences will be equally significant.
It is high time the UPA acknowledged the impossibility of the dream it is peddling.
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First Published: Mon, Jan 21 2013. 10 22 AM IST
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