Monsoon dependence

Food inflation can increase risks

The Union government is backing the Reserve Bank of India (RBI) with measures to contain inflation. After having indicated that it was willing to use trade policy to contain prices, the government last week decided to impose an export duty on onions. This, however, was not the first step. The government recently imposed restrictions on exports of rice and the stockholding of some other food items, such as pulses. The consumer price index (CPI)-based inflation rate nonetheless increased to a 15-month high of 7.44 per cent for July, and is expected to remain above the central bank’s tolerance band for August as well. Since the rate is driven largely by food prices, the relative uncertainty over the progress of the monsoon owing to the El Nino effect has increased risks.

Lower rainfall in different parts of the country could affect agricultural output. A recent study by economists at the RBI noted that the southwest monsoon remained important not only for kharif but also for rabi crops. The impact of the monsoon remains statistically significant for kharif crops but has come down in recent years. The improvement in irrigation infrastructure has helped mitigate the adverse consequences of deficient rainfall. For instance, the overall production of rice and other foodgrains has increased every year since 2016, despite the rains being lower than normal in four years. However, while the elasticity of food production to the monsoon has come down, overall rainfall remains fairly relevant. A 21.4 per cent deviation in rainfall in 2009, for instance, resulted in a 12 per cent decline in food production. Thus, the progress of the monsoon remains important. All states are not equally endowed with irrigation facilities.

While there is merit in preparing for lower food production, the government’s action is often not in the interests of the farm sector, and potentially impedes an adequate supply response. A relatively high price is a signal to producers to increase output. But if the government often imposes restrictions on exports to contain prices, farmers would be reluctant to make additional investment to increase production. Such measures also affect India’s credibility as a reliable supplier of farm products. They are aimed largely to contain prices in the domestic market with a short-term view. Economist Ashok Gulati and others, for example, have shown that India’s policies in this context have had a pro-consumer bias, which affects the revenue and earnings of farmers. The government should desist from such interventions and support the farm sector with a long-term view, which will help increase investment and production.

While the government’s response to high food prices is understandable, though not always desirable, things are more complex for the RBI’s Monetary Policy Committee (MPC). The committee in its last meeting left the policy repo rate unchanged and decided to sit out the expected spike in inflation, which is being driven largely by vegetable prices. Monetary policy intervention is unlikely to have the desired impact in such a situation. The understanding is that such price shocks are transitory and reverse quickly. However, the persistence of price pressure may warrant policy action because it could start affecting expectations. This is where the monsoon will be crucial. It is worth noting that cereal prices tracked by the CPI are also witnessing a double-digit inflation rate. Lower than expected foodgrain production thus could increase risks. The picture should be clearer by the next scheduled meeting of the MPC in October.