Subir Gokarn: A question of dal-roti

Even as the share of agriculture in GDP shrinks, it still has the ability to spoil the party.

The inflation rate persists at a level well above 6 per cent per year, driven primarily by food prices. After being in a macroeconomic comfort zone for quite some time, the government clearly faces a major challenge in dealing with this situation, particularly because it is not really amenable to the traditional anti-inflation medicine of monetary restraint. I had argued in my previous column that there were also signs of demand-pull inflation in the economy, reflected in the inflationary pattern amongst manufactured goods. This should be responsive to the combination of repo rate and cash reserve ratio measures that the Reserve Bank of India (RBI) is implementing. But, food prices are a different animal altogether.

Current pressures on food prices are a combination of temporary and structural factors. Periodic disruptions in the cultivation of various vegetables and fruits cause prices to rise, but these are typically short-lived and prices return to normal as the next crop comes in. There is really very little room for policy intervention. Conversely, while there is a lot of room for policy intervention as far as the structural factors are concerned, these will only have an impact over time; immediate relief is not on the cards.

The two crops in which the impact of structural problems is most manifest are wheat and pulses. A look at the pattern of price increases in these products in the context of their supply situation is instructive. As far as wheat is concerned, with the exception of a couple of months in early 2004, for four of the last five years, the annual rate of increase in wholesale prices never exceeded 5 per cent. Even in those exceptional months, the rate was only a bit higher than that mark. However, in January 2006, the rate of increase accelerated sharply to 9 per cent. Although it dipped close to 8 per cent in a couple of months subsequently, it has stayed well above 9 per cent for most of the last 14 months, hovering in the 17-19 per cent range for much of the latter half of 2006.

During this period, production was quite volatile. From a peak of about 76 million tonnes in 1999-00, total output has hovered in the 65-70 million tonne range over the next few years. In a couple of years, it exceeded 72 million tonnes and, fortunately for consumers, it is expected to do that during the current year. In a scenario of declining or stagnant production, stocks hold the key to price stabilisation. What has happened on this front?

A few years ago, the High-level Committee on Foodgrain Stocks, chaired by Prof. Abhijit Sen, had recommended an optimal reserve of about 22 million tonnes, comprising about 14 million tonnes of rice and 8 million tonnes of wheat. Of course, this number should change over time, but it nevertheless provides a benchmark, significant deviations from which should have an impact on prices. At the end of 1998-99, wheat stocks were 9.7 million tonnes. They climbed steadily over the next few years (remember, production was stagnant), peaking at a huge 26 million tonnes by the end of 2001-02. They declined to about 16 million tonnes in the subsequent year, but after that fell precipitously to 4.1 million tonnes by the end of 2004-05. They are unlikely to have recovered very much since then, but the point is that that fall seems to have triggered, with a few months' lag, a sharp and sustained increase in the rate of price increases.

The price rise for pulses is even starker. Looking back over the past five years, from the beginning of 2003 until early 2005, wholesale prices of pulses were actually declining for the most part. Around June 2005, there appeared to be a decisive shift towards steady price increases. In November 2005, the annual rate of increase crossed the 10 per cent mark to clock 13.4 per cent. Over the 12 months of 2006, the average annual rate of increase was about 32 per cent, with the highest rate of month-on-month increase (October 2006) being almost 44 per cent. The situation has moderated somewhat, but hardly enough to provide relief; the January and February 2007 rates of increase were 24 and 22 per cent, respectively.

Over this period, production displayed a pattern entirely consistent with the price movements for a commodity that cannot be stocked. Output rose in the first few years, during which prices were falling. It peaked at almost 15 million tonnes during 2003-04, the year of the fabulous monsoon. It declined in subsequent years, though by apparently not as much as to trigger the extremely sharp price response. Demand-side factors are presumably also at work here. However, the bottom line is that a widening supply-demand imbalance is putting enormous pressure on prices. Production will, no doubt, respond favourably in the next cropping cycles, but, significantly, less than 15 per cent of the area under cultivation for pulses is irrigated. A positive supply response will depend heavily on the performance of the monsoons.

Could we have imported our way out of this situation? Possibly, as far as wheat is concerned, had we acted when stocks were showing signs of falling below the optimality benchmarks. It may be too late now; as the RBI Governor's statement on January 31 pointed out, the global wheat market is particularly tight right now and likely to remain that way for some time. Not really, as far as pulses go; we are by far the largest producer and consumer of pulses in the world and international markets are extremely thin.

The above analysis highlights the imperative for a variety of agricultural reforms that people have been talking about for years but never reach implementation. We can now expand the range of consideration to cross-border cultivation arrangements for pulses, like China is doing in some Latin American countries, to secure long-term food supplies and we are doing for oil. But, as I said before, none of these is going to provide immediate relief. "Let them eat paneer" will invite the same political reaction as it did in France around the time of the French Revolution. One possible measure: cash relief to households that have been identified to be below the poverty line. But, can we trust our governance mechanisms to target this effectively? The bottom line: even as the share of agriculture in GDP shrinks, it still has the ability to spoil the party.

The author is chief economist, Crisil. The views here are personal