Food prices are rising again. Consumer price inflation (CPI) accelerated to 5.4% in June due to higher food prices. Inflation in pulses and products was up 22%, while vegetable prices moved up 5.4% from a year ago. Compared with the previous month, vegetable prices rose sharply by 13.5% and pulses by 8.8% in June, according to the wholesale price index data.
Structural issues continue to haunt food inflation in India. In a note dated 13 July, HSBC Global Markets Research said the June CPI print is a harsh reminder that food prices—and by extension, the Reserve Bank of India’s (RBI’s) 4% inflation target for FY17 and thereafter—will remain at the mercy of exogenous events such as rains until structural reforms in food production and distribution are expedited.
The point is that while lower increases in minimum support prices and better supply management have brought down cereal prices, agricultural productivity has not seen much improvement. Comparative yields of major crops such as pulses, wheat, rice, oilseeds and vegetables are significantly lower for India compared with peers and developed markets, as can be seen in the accompanying chart by Nomura Global Markets Research.
Why are yields so low in India? One reason is the small size of land holdings, which makes mechanization difficult. There is no incentive for farmers to diversify. The government’s handholding of agriculture has resulted in continuation of archaic practices such as focusing on wheat and rice, which account for 60% of acreage, although the government granaries are flooded with these crops.
Also, thanks to middlemen, there is a mark-up of up to 75% in the agricultural supply chain between the producer and consumer. The village-level trader, commission agent, wholesaler and retailers, all increase prices in the supply chain, says Nomura Research. Farmers continue to make very little gains which are generally cornered by middlemen. Each state has its own agricultural policy with multiple taxes leading to many isolated markets dominated by middlemen who benefit from these price distortions.
In short, until and unless the government goes in for agriculture reforms that address supply-side issues, inflation will remain hostage to high and volatile food prices, which will make it difficult for RBI to achieve the 4% inflation target by 2016-17 on a sustainable basis.