In our country, year-on-year food inflation during the period January 1994 to February 2010 has been unstable: If we graphed its distribution, it would show up scattered with three different peaks at 3%, 7% and 10%. So though the average year-on-year food inflation during the same period was 7.3%, uniform food inflationary expectations aren’t being formed. Consider that the average food inflation for a rolling five-year period—a measure relatively free from temporary spikes in prices and year-on-year base effects and a period corresponding to the full tenors of the government and the Planning Commission—dropped gradually from 9.7% in January 2008 to 0.65% in November 2003 and then rose gradually to 10.5% in February 2010. It is possible to conjecture that the current high food inflation is being driven by inflationary expectations based around the peak at 10%. High inflationary expectations matter because if both the buyer and the seller expect a price to move higher, the price increases even if the demand and supply situation is unchanged. The effect on price increase is accelerated as buyers rush to buy and sellers hoard.
At the core of addressing the food inflation problem facing our poorest—who are net consumers of food—is to firmly anchor the price of food. One way of doing so for India’s poorest is by introducing “special food vouchers” that are backed by rice, wheat or milk. These special food vouchers would have an expiry date, no end-use restrictions and would be used for transactions with both producers and poor consumers.
The government—through the Food Corporation of India (FCI) and state food corporations— holds a significant amount of foodgrains as buffer stock. But this stock is rigid. As the second chapter of the Economic Survey 2009-10 entitled “Micro-foundations of Economic Growth” points out, a rigid buffer stock means the market knows that foodgrains from the buffer are never going to be added to the supply; this will never help cool prices. So there is a one-time permanent upward shift in the food price levels even when the buffer stock is stable, not to mention an increase in prices when the buffer rises. Thus, we need to have a flexible buffer stock level.
Graphic: Ahmed Raza Khan / Mint
More importantly, to control food inflation, the government, through FCI or the National Dairy Development Board, could issue special food vouchers linked to rice, wheat and milk. Let me explain.
Each special rice voucher corresponds to an irrevocable right to the holder of this voucher to get 1kg of rice of a defined quality (there would, no doubt, be premia and discounts for other varieties or grades of rice) through the public distribution system (PDS). During grain procurement, FCI can pay the producers a fixed amount, say four-fifths of a “special rice voucher” per kg of rice of the defined quality (with premia/discounts for variations in varieties). The government will grant special rice vouchers to the poor, similar to the oft-proposed direct cash transfers. The poor may use the special rice vouchers for getting rice from FCI. Similar procedures would be used for special wheat vouchers and special milk vouchers.
FCI would be allowed to issue, say, special rice vouchers to the extent of its buffer stock of rice. In case of a shortage in the market, FCI shall release, from its buffer stock (through PDS), a quantity that is demanded by consumers having special rice vouchers. This will free the buffer stock from rigidity and political interference; the buffer stock level shall no longer be determined in an ad hoc manner.
Producers and consumers would be free to opt for either payments/receipts in rupees or in the form of special food vouchers. In case of milk, milk powder may be a more suitable candidate as it has a longer life than fresh milk. By introducing special food vouchers for both producers as well as poor consumers, the government can escape from the contradiction of wanting to pay producers (rich farmers) more and wanting to ask the poor consumers (net consumers of foodgrains) to pay less.
The two most important functions of money are as a medium of exchange and as a store of value. Traditional money systems (when inflation is within reasonable levels) can do a good job at the latter. However, they are often lacking in the former. Ten poor people may be unable to trade goods and services between themselves because they lack money.
Special food vouchers will necessarily have an expiry date corresponding to the expected life of the corresponding commodity. In effect, this imposes a strong incentive against holding the special food vouchers and in favour of exchanging it. This would mean that the special food vouchers could better serve the medium of exchange function. This makes it more likely that one of the 10 poor people will get access to this special food voucher. Once there are some special food vouchers in circulation, the 10 poor people’s exchange of goods and services will get a boost. This is because special food vouchers will have no end-use restrictions, i.e., a special rice voucher may be used towards payment for a television set—as is discussed in the Economic Survey in the case of fertilizer coupons. Bernard Lietaer’s The Future of Money (2002) offers more detailed illustrations for boosting this function of money.
But would the prices in terms of conventional rupees continue to rise? Yes, that’s possible. However, it will not adversely affect those who are most vulnerable as they can opt for benefits through special food vouchers.
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AM Godbole is an adviser with AV Rajwade & Co. Pvt. Ltd, a risk management consulting firm