Prices Rise, Hope Falls

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India is experiencing a heavy inflation in prices of food products. The escalated prices have given the common man nightmares and have taken a heavy toll on the psyche of almost every consumer. 

By Gaurav D.

Food prices have become a major talking point for almost everyone in India, including the media. The government has unveiled some short term measures to curb prices. The problem, however, is not short term in nature.  The price rise is variously blamed by the different government representatives on last year’s drought, on “cost push” and on “dysfunction in distribution.” The government has been fairly candid in admitting its helplessness in combating the price rise.

Several questions arise. Why have prices risen? Are farmers benefiting from the rise? And why is the government so helpless?

In any discussion of food price rise, it is not long before one hears the word “drought” — last year’s drought is assumed naturally to be the main reason behind the price rise. The facts, however, say otherwise. The possibility of a drought became apparent barely few months back (July 2009) and its effects — a below average crop of paddy, pulses, potatoes (Kharif crop) and sugar — would only begin to be felt with lower arrivals in the market from October onwards. Last year’s drought could acc-ount for the price rise over the last two months; prices however have been on the rise since the beginning of 2008.

The case of rice is illuminating. Prices rose sharply in 2008 after record harvests in 2007 and indications of a higher production in 2008. Was the rise a “cost push” effect — due to  the higher Minimum Support Price (MSP) for paddy fixed by the Government each year?

Comparing the rise in retail prices with the rise in the price paid to the farmer should provide some answers. The MSP announced as the price per quintal of paddy has been converted into an effective price per kg of rice using the standard assumption that paddy will yield 67 percent by weight rice on milling for comparison. 

Of the additional Rs.7 that the customer in Delhi pays now compared to 2 years ago for 1 kg of rice (typically of the lowest quality, available from a government outlet), about Rs.3 goes to the farmer while Rs.4 is the increase in the markup of the retail price over the price paid to the farmer. The increased payments to the farmer in themselves would account for an increase of 9 percent in rice prices each year over the last two years. The difference between the retail price and the price paid to the farmer — accounting for the cost of milling, storage, transportation, taxes and the commissions of the traders, wholesalers and retailers in the supply chain — has inflated by over 80 percent in the last two years and by over 75 percent in just 2008. What can account for this inflation?

Sugar is another example of a problem that has been some time in the making. The Central government declares a Statutory Minimum Price (SMP) for sugarcane every year to set expectations for the farmer (renamed as “Fair and Remunerative Price”). Some states, including UP — the largest sugar producing state — declare a State Advisory Price (SAP) that sets a higher minimum price to be paid by mills for the sugarcane; others, like Karnataka, are content with the Center’s minimum price. The effective price realization of the farmer is calculated with the standard assumption that a quintal of sugarcane will yield 9 kg sugar — thus the Rs.130/quintal price of sugarcane fixed by the UP government translates to Rs 14.45/kg of sugar.

The current crisis of sugar availability is largely of the government’s own making. It allowed the export of sugar on the back of record production in 2006-07 and 2007-08. Initially prices in the world market were higher than Indian prices and traders and exporters booked their profits. In 2007, the world market prices fell. The Central government, however, continued to push exports by waving taxes and providing a subsidy to exporters. In the three years from 2006 thru 2008, a total of over 9.5 million tons of sugar were exported. The average price realization of these exports of raw sugar in the period after April 2007 was only Rs 11.76/kg.

The government has been importing sugar for past two years at roughly double the unit price of earlier exports. Export when prices are low and import when the prices double — that is India’s sugar story of past four years.

Clearly, neither “cost push” nor drought really accounts for the food price inflation. The larger causes are the “dysfunction in distribution” and a government policy which is short-sighted and makes no contingencies for the vagaries of nature. The “dysfunction in distribution,” in plain speak, stands for speculative hoarding all along the supply chain from farm gate to consumer’s table. And the government policy of exporting surplus agricultural produce without saving for the rainy day profits no one but traders.

It will now be clear why the government is helpless. While cracking down on hoarding could bring some relief temporarily, it is a difficult option for the governments at the center and in the states, since the trading community is a major source of funds and has close connections with the political parties and politicians. For the government’s economic advisors, this is also anathema — it militates against the direction of reforms to free markets from all shackles. The preferred policy is to correct the markets through imports, but this will not work when international prices are higher or when the requirements are so large that the initiation of imports would drive up world market prices. Unfortunately, this is just the case now with pulses and with sugar.

It is perhaps time to rekindle the debate on the need for near self-sufficiency in essential foods and investment in food storage infrastructure.

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