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India
The visible hand: Government intervenes to tame food inflation
Under pressure, the government last night announced measures to tackle rising food inflation. The measures are likely
to have some impact in the short term, but it is likely to be limited and will depend on implementation. Also, structural
measures to improve productivity in the agricultural sector are still needed. So, inflation pressures from food and nonfood sources will remain and require ongoing RBI attention through rate hikes.
Facts
The government last night announced a series of measures to curb elevated and rising food inflation, including the following:
• Onions, including imports from Pakistan, will be sold through agricultural co-operative outlets at nearly landed costs, cheaper
than prevailing market prices.
• Export and import policies for essential commodities will be reviewed regularly, with further bans on exports imposed or
restrictions on imports lifted as needed safeguard supply to domestic markets.
• State-run enterprises are to intensify purchases of essential commodities (edible oil and pulses) for distribution through their
network and through the public distribution system (PDS). This is an attempt to control retail prices and increase supply in the
PDS (outlets that distribute rationed commodities at subsidized prices)
• Other broader measures include: action against hoarders and cartelization by large traders, attempts to influence consumption
patterns towards cheaper alternatives, organizing farmers and cooperatives better, urging state governments to remove local
levies, etc.
An inter-ministerial group that monitors the price situation and recommends action will be set-up.
Implication
Food prices have basically drifted up and remained elevated due to the following factors: (1) a structural supply-demand
imbalance, (2) crop destruction, more recently, due to the extended monsoon and cold weather in certain regions, and (3) the
strong cyclical demand for foods due to the strength of the broader economy.
The structural supply-demand deficit is the result of a couple of this. Low productivity in the agricultural sector as well as
wastage of food due to transport and storage deficiencies is holding down end-supply. Moreover, on the demand side there
has been a structural shift in consumption patterns towards high-protein foods as the country has developed and more people,
consequently, can afford these products. However, the shift in demand has not been met by a corresponding increase in
supply and has lifted food prices for this segment. To address these more chronic issues you need structural reforms to raise
productivity in the sector and strengthen supply chains, including more cold storage facilities. That will take time and the
announced measures are concentrated more on short term relief.
The weather-related crop destruction for onions and other vegetables is being tackled more directly by these measures by
bringing more food to the market through various channels. The steps taken should, therefore, help contain price pressures on
that front, although not dramatically so and it also depends on how swiftly and efficiently the measures are implemented.
The cyclical uptick in food prices due to the strong recovery in growth and associated demand-led pressures is not targeted
through these measures. This is where RBI comes in and still has its work cut out for it. They also have to look out for any
second-round impact from higher food prices on core inflation components. So, the task ahead for RBI has not changed. They
need to tighten further to slow the economy down and tame demand-led inflation pressures, including on food prices. We have
long called for a 25bp hike in January and stick to it. Following this, we expect an additional 100bps in 2011.
Bottom line: The measures announced by the government will provide relief in the short term, but the impact is likely to be
limited and the more chronic problem of food supply-demand mismatch remains unresolved. There are also internationally an
upward drift in food prices. With demand-led price pressures adding to the challenge, RBI needs to tighten further and will
resume on January 25 with a hike of 25bps and finish 2011 125 bps higher than today.
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