India’s food inflation: Is this time different?

A superb speech from Subir Gokarn of RBI. Though this issue of food inflation has been analysed to the pulp, there is always scope for more juice.

In this speech he shows how India has suffered from high food inflation for most periods since 1950s. The food inflation eased in 1990s fueling complacency and again rose in 2000s. The drivers  of food inflation have changed from cereals to protein and fruits & veggies now. So, though we may say this time is different, reality is it is not. Food inflation has been a result of sluggish supplies which have not kept pace with rising demand and population. So, may be the players/drivers of food inflation have changed the overall issue of high food inflation remains. Much like the case we see for financial crisis as shown by Rogoff-Reinhart.

Turning to the topic of today’s lecture, the title is admittedly borrowed from a recent book, the very influential historical work on financial crisis by Carmen Reinhart and Kenneth Rogoff¹. Besides being a very catchy title, which is always very tempting to borrow, I felt that there was some similarity between the historical dynamic described in the book and the situation we are facing with food inflation in India today. Crises recur because there are just enough differences between the circumstances that cause them for people to be able to deny their inevitability. However, the underlying drivers of virtually every crisis are essentially similar. In the story of financial crises that the book tells, unsustainable build-ups of exposures, underestimation of risks and an erosion or inadequacy of regulatory capacity are the common elements of all crises.

When I joined the RBI, food inflation had been a headline issue for almost two years, beginning late 2007 and consolidating very sharply in the first half of 2008. There was definitely a global dimension to this during that period, but what was striking was that even after global food inflation moderated, Indian food inflation persisted. The weak monsoon of 2009 was, of course, blamed and we all believed that softening was only one good monsoon away. Well, 2010 was a good monsoon but, as it turned out, there was little respite in food inflation. Let’s wait for 2011, we thought. 2011 was also a relatively good monsoon year, but in the immediate aftermath of the monsoon, there wasn’t much respite. Fortunately for policymakers, data from recent weeks suggests a softening in food inflation, but the level is still rather high.

 Couple of interesting analysis in the speech.

• First he picks inflation data since 1950s when average inflation is above 10. There are 13 such episodes with episodes in 1966-68 and 1972-75 at 20% average. Current inflation starts from 2008 and average is around 14%
• The persistent food inflation in terms of high inflation for continuous months is highest now. Currently we have high food inflation from Sep-08 to Oct-11 which is 36 straight months. High food inflation episodes of 1960s and 1970s lasted 35 and 32 months respectively. So, in terms of average inflation figures are lower but in terms of persistence this episode is more prolonged.
• The change in drivers of food inflation. In 1960s and 1970s it was cereals and sugar and now it is proteins, fruits and veggies
• Within proteins it is milk which has been on a run from 2008 onwards and joined by eggs meat and fish later. Pulses was in the game earlier but has faded now
• Then he shows how rising income leads to a higher rise in demand/expenditure for protein items. He does this via Engels  curves for both rural and urban
• Then he moves to supply side issues and shows productivity has not kept pace on both pulses and milk. On pulses he points to regional tastes:

  I have not gone down to the next level of disaggregation, looking at productivity patterns across different kinds of pulses. Some of the inter-state variation is because the crop mix is different across states. The distinction is important because of strong inter-regional variations in preferences. Specifically, consumers in the western and southern regions have a preference for tur (orarhar) dal, while chana and urad are more popular in the north. Masur comes into the mix in the east. Because of the relative lack of substitutability between these varieties, strategies to increase productivity need to take into account the supply-demand imbalances in each of these items. A large increase in a pulse variety that is not universally consumed will not be of much help in addressing the demand-supply imbalance

  Going back briefly to Slides 7 and 8, in which the relative contribution of pulses to inflation was displayed, one reason why it has been muted at the aggregate level is that not all pulses face the same demand-supply imbalance. For example, chana, which is a significant Rabi crop in the northern region, has been relatively stable in its yields and this in turn has resulted in relatively stable prices. On the other hand, tur, which is grown largely in the southern half of the country, has shown much more volatility in productivity and has, as a result, shown much sharper increases in prices over the past few years.
  

•  He also points how long period average of rainfall has been declining in each decade. This means regions which get less monsoons  are likely to get lesser share going ahead. These regions are Central India which is critical for pulses:

I want to address one final issue on the supply side before I conclude. This has to do with the performance of the monsoon over a long period of time. We are used to thinking of “normal” or “deficient” monsoons in terms of a deviation from a benchmark labelled the “Long Period Average” (LPA). The LPA for a specific decade is the average of the rainfall over the 50 years before that decade. It is, therefore, updated every ten years, after the completion of a decade, which then gets added into the average. However, if the benchmark itself is changing, the notions of normality and deficiency do not fully capture the absolute amount of rainfall in any given year. A normal monsoon in one year may actually deliver less rainfall than a normal monsoon in another.

35. Slide 18 displays the LPA for the South-west monsoon across the country. It clearly shows a declining trend. This means that normal monsoons are actually delivering less water than in the past. This may not be of great significance for regions that are subject to heavy rainfall, but in parts of the country, particularly in the central regions, this kind of decline may be contributing to water scarcity and, consequently, keeping productivity stagnant. Notably, pulses comprise a significant crop in these regions. In short, to add to all the other hindrances to productivity growth, long-term water availability will also potentially play a role.

Finally, we are back to food inflation situation seen in 1970s:

Let me now wrap up the lecture by highlighting two key points made in the lecture and then drawing out some policy implications. First, we seem to be currently in a situation that resembles the food inflation episodes of the early and late 1970s in terms of magnitude and duration. In all three comparable episodes, including the most recent one, two important categories of food made significant contributions to inflationary pressures and their persistence. However, the key difference between the earlier episodes and the recent one is the pair of commodities involved. Earlier, it was cereals and sugar, now it is proteins and fruits and vegetables.

Second, when prices are rising because demand is growing strongly while supply stagnates or fails to keep up, there is no alternative to curbing food inflation than raising supply rapidly. The current pressure on the prices of proteins and fruits and vegetables is clearly the outcome of this combination of circumstances. However, raising productivity quickly is itself a serious challenge, given the pressures emanating from both labour costs and, over longer horizon, what appears to be a structural reduction in the absolute amount of rainfall.

Hmmm.

Read the whole thing. Superb stuff from Gokarn…No times are really different..