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Inflation management: Time to explore an alternative paradigm

While the government banned wheat exports in May 2022 soon after claiming to feed the world, subsequent actions on stock limits have only created a fear of rising prices.
While the government banned wheat exports in May 2022 soon after claiming to feed the world, subsequent actions on stock limits have only created a fear of rising prices.

Summary

We must protect consumers without sacrificing either economic growth or the interests of farmers

Inflation continues to be a worry for India’s government. Consumer Price Index (CPI) estimates show that it moderated to 6.8% in August from 7.4% in July. Even food inflation has come down from a high of 11.5% in July to 9.94% in August, even though it’s still too high. The dip is primarily a result of moderation in vegetable price inflation, which has declined from 37.4% in July to 26.1% in August. However, two major food categories, cereals and pulses, continue to show double-digit inflation. There is unlikely to be a downward trend in both these, given the domestic as well as international price situation.

Food inflation has been a tricky beast to tame, as acknowledged by the Reserve Bank of India (RBI) in its monthly bulletin. Monetary authorities have been tasked with the enviable job of reducing inflation, even though food price-rise of the kind we have seen is unlikely to respond to RBI’s tools. Speaking at a B20 meeting organized by the Confederation of Indian Industry on 25 August, finance minister Nirmala Sitharaman cautioned against raising interest rates for inflation control at the cost of economic growth.

Attempts by the government to control inflation through coercion and bans have largely been counterproductive. Much of our food price inflation, especially in cereals and pulses, is a result of domestic supply shocks. In the case of wheat, it was a heatwave and unseasonal rains which hit output. In the case of rice, unevenly spread and deficient rainfall is to blame. While international price movements have also played a role, the government’s reaction worsened matters. Boasting of “record output" when all indicators pointed to a decline hurt the credibility of its efforts. While the government banned wheat exports in May 2022 soon after claiming to feed the world, subsequent actions on stock limits have only created a fear of rising prices. It fared no better on rice, with a ban on common variety exports followed by a minimum export price for basmati. The situation in pulses is similar. Their output has been declining for the past two years. As against a target of 4.6 million tonnes of tur production, third advance estimates for the current year suggest overall production of just over 3.4 million tonnes, the lowest after 2018-19.

While the steps taken by the government have been largely ineffective and it has failed to meet its procurement targets for the last two years, the cost of its inflation-control measures are borne by farmers. Given that the supply shocks were well known, a better strategy would have been to raise procurement prices to get more from farmers. Higher procurement and distribution of cereals and pulses through the Public Distribution System (PDS) would have been a better way to insulate people’s diets from inflation. This would also have helped farmers suffering from rising input costs and the vagaries of weather. Instead, the government withdrew the additional foodgrain entitlement introduced during the pandemic.

Coercive measures have only created panic in the market, putting upward pressure on prices. While farmers have managed to get better prices in markets, rising input costs meant their incomes have not increased proportionately. Consider the terms-of-trade for farmers by means of an index showing indices of prices they received for their produce as a proportion of indices of prices they paid for final and intermediate consumption plus capital formation. A ratio of more than 100 suggests favourable terms of trade. But it has been adverse since 2010-11. In 2021-22, it declined to 97.1 from 99.4 in 2020-21. In other words, farmers have not benefited from higher farm-product prices because of rising input costs.

Inflation management is largely a political economy issue. Monetary policy is hardly useful when inflation is a result of supply shocks and ad-hoc policy decisions. But taming prices with market-distorting tools is not easy either. In both cases, the approach taken has its costs, be it in terms of sacrificing growth or the interests of farmers. While this is part of a larger political economy paradigm that privileges consumers over producers, the cost of such measures is greater than their benefits. At a time when the rural economy is already in distress, the use of instruments that distort markets is unlikely to solve our inflation problem. But it will surely worsen rural demand, which has been in a slump and threatens a wider economic recovery. India needs an alternative paradigm of inflation management that protects our consumers without sacrificing either economic growth or the interests of farmers.

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