Photo: Mint
Photo: Mint

Opinion | Has India cut the inflation Gordian knot for good?

Facing fiscal pressure due to income support is better than facing food shortages-driven inflation

Global investors and economists have been worried about India’s high inflation problem for long and for the right reasons. The growth slowdown in many emerging markets—2017-18 in Turkey, 2015-16 in Brazil, 2015-16 in Russia—are all examples that show linkages between high inflation and economic crisis. While India’s consumer price inflation (CPI) brushed high levels many times, it never crossed the tipping point. In fact, Indian CPI has been undershooting economists’ expectations for the past few years. Average CPI between 2007 and 2013 end was 9.5%. This has reduced to 4.5% over the last five years. The primary reason for this reduction is food inflation which has nearly half the weightage in overall consumer inflation. Food inflation has reduced from 10.7% to 3.9% over the same period. Over the last two years, food inflation has actually averaged at less than 2%. What’s the reason for this low food inflation and is this sustainable?

Let us first of all understand the circumstances in which this low food inflation has been achieved. Over the last five years, monsoon has been 9% below normal on average, implying that rainfall has been deficient. Government spending on the Mahatma Gandhi National Rural Employment Guarantee Scheme, which is considered inflationary by many, has risen 76% over the last three years to 61,100 crore in fiscal year 2019 (FY19). This is quite a steep increase. The minimum support price for paddy was raised by a steep 13% for FY19. All these data points could have easily pointed towards a higher food inflation.

Now let’s understand the characteristics of the inflation. Reduction in food inflation has been uniform across nearly all food categories including cereals, pulses, meat and eggs, milk, fruit and vegetables. Inflation in all these subcategories has been 3% or below during the current fiscal year. Pulses have been witnessing deflation for the last two years. Interestingly, production growth across all the categories has been way higher than the population growth over the last 10 years. Compared with the population growth of 14% over the last 10 years, production in pulses, vegetables, fruit, milk, eggs and meat has grown between 40% and 84%. If we apply the general rule of 70:30, implying that 30% of the richest population consumes 70% of the high-protein food items such as meat, eggs etc., it is fair to assume that demand here would have only grown in line with population growth as people are already well-fed. This implies that the high-protein food availability for the bottom 70% of the population has doubled or grown at more than 7% compound annual growth rate. A 7% growth would be good enough to feed the rising demand from the bottom 70% with rising incomes. It is no wonder that food inflation has stayed low with this sort of a demand supply dynamic.

With the overall land under cultivation seeing a marginal decline over the last 10 years, the reason for this high production growth, clearly, is improving productivity. Several efforts made by successive governments are finally paying off. Farmers have slowly shifted away from cereals to more profitable pulses, fruits and vegetables. A 1% reduction in the gross cropped area for cereals has helped increase the area under cultivation for pulses and fruits and vegetables by 27-29%. Net irrigated area under cultivation has risen from 62 million hectares in 2010 to 68 million hectares by 2015. Since 2010, 5 million new tractors have been sold. Over the last 10 years, 400,000km of rural roads have been built under the Pradhan Mantri Gram Sadak Yojana, which has reduced the transport time to market for foodgrains and other perishable food items, reducing wastage and effectively improving yield. And of course, improvement of farm techniques has helped productivity as well. Non-governmental organizations like Tata Trusts are working tirelessly with farmers in eastern Uttar Pradesh to educate them on how to improve yields. For example, the use of better quality seeds, better quality cattle feed, root treatment, raised bed plantation for onion, multi-layering, ridge and farrow method for sugarcane, intercropping etc., have helped increase yields. Our interactions with farmers in that area reveal that more productivity gains are possible as these initiatives get rolled out to more and more farmers. The experiment of farm machine banks can also be made more widespread to improve yields and ensure high food production growth sustains for years to come.

If this theory is right, then, India has probably solved its inflation problem for good. Of course, seasonality- and base effect-driven fluctuations in food inflation are still possible. On the flip side, low food inflation affects farm incomes as higher volumes cannot offset the impact of lower price. Also, the benefits of higher production are limited to more educated and larger farmers. Small and marginal farmers have been unable to reap the volume gains. The long-term solution for this problem is to reduce the number of people that are dependent on farming by offering them vocational training. But this is a time-consuming process and will likely take a decade or two. In the interim, governments will be under pressure to boost farm incomes by offering income support schemes, thus creating fiscal pressures. However, this is a better problem to handle than the problem of food shortages-driven higher inflation, which ultimately leaves us with macro imbalances.

Mahesh Nandurkar is an India strategist at CLSA, Hong Kong.