MacroScan (Printable Version) - Is Food Inflation finally coming down?

The past three years have witnessed a period of very rapid and sustained increase in food prices, which has very significantly affected the living standards of the bulk of the Indian population. Food price inflation has been in double digits for an extended period, and all the declared policies of the government have done little to reduce it. Indeed, some policies such as the deregulation of petrol prices may well have further contributed to such inflation.

For almost a year now, some important policy makers and spokespersons of the government have been promising that food inflation will come down to 6 per cent within a few months. This claim has been made periodically since last October; yet, food prices have continued to rise at very rapid and even increasing rates.

This has also led to a change in the official policy thrust, towards inflation control through monetary policy notwithstanding the negative effect this may have on output and employment. Thus the Reserve Bank of India is so concerned about the continuing high rates of food inflation (which it interprets as reflecting excess demand) that it is increasingly veering towards putting up interest rates in order to restrict price increases. But there are several reasons why this is not likely to be the appropriate strategy.

Chart 1 shows the year-on-year rate of food price inflation over the past year by week. The rapid increase in the food inflation rate to 20 per cent and more from November 2009 reflected the impact of the poor kharif harvest consequent upon the bad monsoon. This was coupled with the effect of adverse expectations. The food inflation rate remained persistently high for nine months thereafter. It is worth noting that there was no deceleration even after the rabi harvest, which (while not particularly good) was certainly not as bad as the previous kharif.

It is only in the past three months that there has been some deceleration in the year-on-year food inflation rate, although it still remains very high at around 15 per cent in annual terms.

Another way of tracking the seasonal movement of food prices is to look at the quarterly rate, that is, the rate of increase in food prices relative to the previous quarter (13 weeks previously). Chart 2 provides this information, and suggests that there was some effect (although muted) of the incoming rabi harvest on overall food prices, which actually fell in March and part of April. It is also evident from Chart 2 that the most recent kharif season has been associated with a deceleration in inflation (though not yet an absolute decline in prices) as the effects of a munificent monsoon in large parts of peninsular India are felt. This is notwithstanding the relatively poor rainfall that has affected much of the Eastern region.

Looking at the quarterly pattern allows us to compare the current year with two recent years that have been associated with very different patterns of price movement: 2007 (which was a very good year in terms of agricultural output in both kharif and rabi seasons) and 2009 (which turned out to be a very poor year for kharif and only a moderate year for rabi). In 2007, quarterly food inflation rates were moderate but positive until October, and then even turned negative from October, indicating absolute price declines (which are quite normal in periods of good harvests).

In 2009, by contrast, quarterly food inflation rates rose quite sharply between May and July, and then stayed very high until October. The slight deceleration in October and November was not sufficient to ensure any real decline in the year-on-year inflation rate, as was observed in Chart 1. And, of course, the poor kharif harvest in that year meant that the quarterly inflation rate then rose sharply in the last two months of 2009, ensuring the very high annual rates in excess of 20 per cent that were observed from then onwards.

What is particularly interesting about Chart 3 is the food price behaviour that is indicated for the current fiscal year. For the first four months of fiscal 2010-11, the quarterly food inflation rates have looked very similar to those that prevailed in 2009, which as we have seen was a bad year in terms of agricultural output. However, since late August the pattern appears to have changed, and the pattern of price movements much more closely tracks the price behaviour of 2007, which was a good harvest year. Since all indications are that the current year will witness a good kharif harvest, there is sufficient reason to expect that the quarterly inflation rate may turn negative post-harvest, as had occurred in 2007 for example.

If this does actually transpire, then it may well be that the rate of food price inflation will decline in the near future. Chart 4 projects the price behaviour noted from Chart 3 onto the coming months of this year, in terms of the possible implications for the year-on-year food inflation rate. If the seasonal price pattern tracks the movements in 2007, which may be expected because of the good kharif harvest, there is likely to be a decline in the year-on-year food inflation rate to just below 6 per cent in the coming months.

This in turn means that heavy-handed monetary policy measures designed to curb such inflation, especially those affecting the base interest rate, are likely to be excessive and even unnecessary given the likely movement of food prices.

However, this does not mean that there is any justification for complacency on the food price issue, nor does it suggest that the question of food security for the population is any less pressing. Note that much of the decline in food inflation rates that may appear shortly is because of the base effect of very high food prices in the previous year. Also, money wages of most workers (both wage workers and self-employed) have certainly not kept pace with the food price increases.

A further factor must be borne in mind. India continues to be affected by global prices of important food items, and there are clear indications of another price upsurge in food markets in global trade. For example, wheat prices in the Chicago market (which is the typical benchmark for the global trade price) have increased by more than 70 per cent in the three months up to late September. There is once more evidence of speculative activity in the commodity futures markets, driven by index traders. What makes the problem more pressing for India is that the Indian government has once again allowed futures contracts in wheat from May 2009, having lifted the ban specifically for this commodity. If the global speculative pressures affect India, including through the impact on the local futures market, this may provide a source of food price inflation that is unrelated to local supply factors. In such a case, any bets on future food price movements would be off.



Themes > Features	2.11..2010


Is Food Inflation finally coming down?

C.P. Chandrasekhar and Jayati Ghosh

The past three years have witnessed a period of very rapid and sustained increase in food prices, which has very significantly affected the living standards of the bulk of the Indian population. Food price inflation has been in double digits for an extended period, and all the declared policies of the government have done little to reduce it. Indeed, some policies such as the deregulation of petrol prices may well have further contributed to such inflation. For almost a year now, some important policy makers and spokespersons of the government have been promising that food inflation will come down to 6 per cent within a few months. This claim has been made periodically since last October; yet, food prices have continued to rise at very rapid and even increasing rates. This has also led to a change in the official policy thrust, towards inflation control through monetary policy notwithstanding the negative effect this may have on output and employment. Thus the Reserve Bank of India is so concerned about the continuing high rates of food inflation (which it interprets as reflecting excess demand) that it is increasingly veering towards putting up interest rates in order to restrict price increases. But there are several reasons why this is not likely to be the appropriate strategy. Chart 1 shows the year-on-year rate of food price inflation over the past year by week. The rapid increase in the food inflation rate to 20 per cent and more from November 2009 reflected the impact of the poor kharif harvest consequent upon the bad monsoon. This was coupled with the effect of adverse expectations. The food inflation rate remained persistently high for nine months thereafter. It is worth noting that there was no deceleration even after the rabi harvest, which (while not particularly good) was certainly not as bad as the previous kharif. It is only in the past three months that there has been some deceleration in the year-on-year food inflation rate, although it still remains very high at around 15 per cent in annual terms. Another way of tracking the seasonal movement of food prices is to look at the quarterly rate, that is, the rate of increase in food prices relative to the previous quarter (13 weeks previously). Chart 2 provides this information, and suggests that there was some effect (although muted) of the incoming rabi harvest on overall food prices, which actually fell in March and part of April. It is also evident from Chart 2 that the most recent kharif season has been associated with a deceleration in inflation (though not yet an absolute decline in prices) as the effects of a munificent monsoon in large parts of peninsular India are felt. This is notwithstanding the relatively poor rainfall that has affected much of the Eastern region. Looking at the quarterly pattern allows us to compare the current year with two recent years that have been associated with very different patterns of price movement: 2007 (which was a very good year in terms of agricultural output in both kharif and rabi seasons) and 2009 (which turned out to be a very poor year for kharif and only a moderate year for rabi). In 2007, quarterly food inflation rates were moderate but positive until October, and then even turned negative from October, indicating absolute price declines (which are quite normal in periods of good harvests). In 2009, by contrast, quarterly food inflation rates rose quite sharply between May and July, and then stayed very high until October. The slight deceleration in October and November was not sufficient to ensure any real decline in the year-on-year inflation rate, as was observed in Chart 1. And, of course, the poor kharif harvest in that year meant that the quarterly inflation rate then rose sharply in the last two months of 2009, ensuring the very high annual rates in excess of 20 per cent that were observed from then onwards. What is particularly interesting about Chart 3 is the food price behaviour that is indicated for the current fiscal year. For the first four months of fiscal 2010-11, the quarterly food inflation rates have looked very similar to those that prevailed in 2009, which as we have seen was a bad year in terms of agricultural output. However, since late August the pattern appears to have changed, and the pattern of price movements much more closely tracks the price behaviour of 2007, which was a good harvest year. Since all indications are that the current year will witness a good kharif harvest, there is sufficient reason to expect that the quarterly inflation rate may turn negative post-harvest, as had occurred in 2007 for example. If this does actually transpire, then it may well be that the rate of food price inflation will decline in the near future. Chart 4 projects the price behaviour noted from Chart 3 onto the coming months of this year, in terms of the possible implications for the year-on-year food inflation rate. If the seasonal price pattern tracks the movements in 2007, which may be expected because of the good kharif harvest, there is likely to be a decline in the year-on-year food inflation rate to just below 6 per cent in the coming months. This in turn means that heavy-handed monetary policy measures designed to curb such inflation, especially those affecting the base interest rate, are likely to be excessive and even unnecessary given the likely movement of food prices. However, this does not mean that there is any justification for complacency on the food price issue, nor does it suggest that the question of food security for the population is any less pressing. Note that much of the decline in food inflation rates that may appear shortly is because of the base effect of very high food prices in the previous year. Also, money wages of most workers (both wage workers and self-employed) have certainly not kept pace with the food price increases. A further factor must be borne in mind. India continues to be affected by global prices of important food items, and there are clear indications of another price upsurge in food markets in global trade. For example, wheat prices in the Chicago market (which is the typical benchmark for the global trade price) have increased by more than 70 per cent in the three months up to late September. There is once more evidence of speculative activity in the commodity futures markets, driven by index traders. What makes the problem more pressing for India is that the Indian government has once again allowed futures contracts in wheat from May 2009, having lifted the ban specifically for this commodity. If the global speculative pressures affect India, including through the impact on the local futures market, this may provide a source of food price inflation that is unrelated to local supply factors. In such a case, any bets on future food price movements would be off.



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