Droughts and decoupling

Droughts and decoupling
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First Published: Tue, Aug 25 2009. 09 26 PM IST
Updated: Tue, Aug 25 2009. 09 26 PM IST
The drought of 2009 is widely expected to be more benign in term of its economic impact than previous droughts.
Most economists estimate that the drought will reduce India’s economic growth by a modest 1 percentage point. A look at economic performance during dry years in the post-independence period shows that the decoupling of overall economic performance from farm output has not been a sudden occurrence.
India’s gross domestic product reduced after the first three major post-1947 droughts: 1965, 1972 and 1979. But the economy grew after the droughts of 1987 and 2002, as it will grow this fiscal year. Economic growth had dropped by at least 10 percentage points between 1964-65 and 1966-67 and between 1978-79 and 1979-80. Compare that with a modest drop of 0.8 percentage point after the 1987 drought and 2 percentage points after 2002.
This record suggests that the overall Indian economy had started decoupling from its farm sector at least two decades ago. There could be three reasons for this. One, the contribution of agriculture to the overall economy has dropped significantly; two, the rural economy has diversified so that households have some alternative sources of cash flow from rural services and remittances; three, the recent growth acceleration had few links with the rural poor, who were neither employed in new activities nor important sources of demand for modern goods and services.
The third explanation is also a political time bomb, since it suggests that there are now two Indian economies that are only very weakly linked to each other: A modern and globalized economy, on the one hand, and a traditional economy where millions are trapped in low productivity work that  inevitably leads to low incomes, on the other. A crisis in the latter does not affect the former.
Droughts have almost inevitably been accompanied by political firestorms, though I do not know whether there is strict causality between the two. The 1965 drought was followed by both the Naxalite uprising and the first electoral victories by an anti-Congress rainbow coalition, the 1972 drought led to food inflation of over 20% and a nationwide wave of strikes and street agitations, the 1987 drought coincided with the first blows to the Rajiv Gandhi government by its opponents.
The government seems to be following a three-pronged strategy to combat the drought and rural distress. It is bringing into play the usual statist brew of export bans, restrictions on forward trading of certain agricultural commodities, ticking off hoarders and plans to buy food from the world market (which is always based on the neat assumption that other countries will not put their own export bans in place).
The second prong is the National Rural Employment Guarantee Scheme (NREGS), which is expected to provide basic income support to the rural poor though it will continue to make a mess of public finances and raise rural wage rates at a time when farmers are in trouble. The first such rural jobs scheme was launched by the Maharashtra government in 1973; its long-term impact on the state’s rural economy and poverty is still a matter of heated debate.
The third thing that the government is doing is increasing support prices for grains and pulses. The main goal of raising the prices at which the government will buy food from farmers is to create a disincentive for hoarding. Higher procurement could then allow the government to manage food inflation. “While (the move to increase minimum support prices) is aimed at increasing procurement, it could have a knock-on effect on prices—as primary product prices are derived from farm harvest prices, prices at the village mandi, procurement prices or support prices,” wrote Citigroup economist Rohini Malkani in a 24 August research report.
Malkani said NREGS will offer some relief to the small farmer while higher procurement prices and the shift to value-added cash crops will help big farmers.
It will be interesting to see how the government’s three-pronged approach works over the next few months. Assuming it does lessen rural distress, the main challenge will be managing inflation. Real incomes of net food buyers—especially the poor—could be dropping as a result of sustained double-digit food inflation.
Food inflation has been higher than general inflation in only 19 of the 37 years since 1971-72, according to data on average weekly variation in the Wholesale Price Index published in the Reserve Bank of India’s annual Handbook of Statistics on the Indian Economy. And it was far lower than general inflation through most of the current decade.
Higher food inflation benefits net sellers of food and hurts net buyers (especially the poorest who do not have indexed wages and who spend most of their meagre income to buy food). This obvious fact will create several political and social problems that the government may need to manage.
That, rather than the impact of overall economic growth, is likely to be the main challenge of this year’s drought.
Your comments are welcome at cafeeconomics@livemint.com
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First Published: Tue, Aug 25 2009. 09 26 PM IST