The Monsoon May Not Drive India's Food-Price Inflation After All
The monsoon season is a much-vaunted fixture of the Indian social calendar unleashing celebrations as the rainfall brings relief from the summer heat.
It's also seen as a key fixture in the economic calendar.
Mercifully, the Indian Meteorological Department (IMD) in April predicted monsoon rainfall would likely be above normal levels, and fairly evenly distributed throughout the country. The government subsequently mooted an upgrade of its growth forecasts, citing the prospect of lower interest rates thanks to easing food-price inflation.
The development underscores the importance attributed to the monsoon season in shaping the output of India's agricultural sector as well as price pressures that run throughout the economy. But the widely held view that the monsoon is a significant driver of food-price inflation in India is wrong. That's the bombshell conclusion of a Tuesday research report by Societe Generale SA's India economist Kunal Kumar Kundu.
He argues that it's government policies — ranging from the use of ground water in production, to the government's Minimum Support Price (MSP) program offered to farmers to procure food grains — that have a greater impact on food prices than the monsoon.
In fact, he reckons, there's no evidence that a bad monsoon season necessarily results in high food prices.
India's food inflation between 1996 and 1998, for example, was high even when the monsoon season was relatively benign. Meanwhile, between 1999 and 2005, inflation was largely contained during a period of below-normal monsoons, including the 2002 drought.
Instead, it's water levels that hold the key to India's food-inflation conundrum, according to SocGen. Specifically, it's the depletion of water resources that has the most proximate effect on food prices, and government policies there are unwittingly fueling inflation, the analyst says.
"Adequate water levels help to keep overall food prices in check, even during drought years. However, the depletion of fresh water resources, especially ground water, has a major impact on crop production. Unfettered usage has led ground water to be depleted to a level that is considered critical. This is adversely impacting crop production, especially in areas not covered by irrigation facilities."
Policy makers have created incentives for ground-water extraction instead of improving the availability of surface water, according to Societe Generale.
"Not only did the government provide cheap credit and subsidies for irrigation equipment, electricity was supplied for agricultural usage virtually free of cost. This has led to massive exploitation of ground water. As a result, the share of ground water used for irrigation has been steadily increasing so that it now accounts for the lion’s share of the total water used for irrigation."
It's these low ground-water levels that have negatively impacted crops, he concludes.
A second driver of food inflation is rising MSPs as the continuous uptrend in the latter has become a "tool to appease farmers, as their votes can influence election outcomes", Societe Generale writes. "As MSPs form the floor to market prices, they tend to remain elevated even if demand-supply dynamics require prices to come down. Not surprisingly, between [fiscal year 2007] and [fiscal year 2013], India’s food inflation averaged close to 11 percent year-on-year, marking the longest stretch of double-digit food price inflation even though the country enjoyed a normal monsoon in five out of the six years."
Lastly, India's buffer stock policy, focused on cereals, needs substantial improvement, as food grains haven't been released to the market when needed in the past, while domestic consumption patterns have shifted in favour of pulses. "Since 2008, the government has been very aggressive in procuring food grains, and the actual buffer stock has consistently been above the specified norm – at times more than double the norm. Unfortunately, this has not prevented food prices from skyrocketing, as the government failed to bring stocked food grains to the market during periods of shortage, thereby allowing speculative stock-building and black-market activity."
Nevertheless, the current administration has been more proactive in drawing down inventories in production shocks, helping to put a lid on cereal inflation.
Reforming the MSP policy and the agricultural supply chain, more generally, has been subject of debate within Indian policy circles for decades. Kunal Kumar Kundu's work is important as it uncovers the urgent need to improve the efficiency of water usage in agriculture, and the role of policy incentives in promoting production.
It's hard to understate the importance of enacting reforms to the food supply.
Indian food inflation has large second-round effects on core inflation — forcing the monetary stance to be tighter, other things being equal — given the former's influence on price expectations and wage setting, and the outsized share of spending on food in household expenditure.
The good news is that in theory, India has the power to tackle its structurally high headline-inflation problem in order to ease price pressures throughout the economy, rather being held at mother nature's mercy.