Why inflation is so persistent

August 25, 2014

(Any opinions expressed here are those of the author and not of Thomson Reuters)

Inflation has been high for nearly four years and has not responded to the policies of the Reserve Bank of India or the central government. This is because the kind of inflation that we have is of an unusual variety and cannot be checked by conventional means.

It is important to look at the numbers. In July, the consumer price index (CPI) was up 8 percent and threatens to crawl up further after a deficient monsoon. That’s because 68 percent of the increase in CPI comes from food.

In the food basket, the prices of vegetables, fruits and milk have jumped the most. Together, this accounts for 31 percent of food inflation. Of these, vegetables were responsible for the entire increase in July’s CPI.

Vegetables and milk are critical components of CPI and an adequate increase in supply to cover higher demand can make all the difference. Demand should not be curbed in the interest of a healthy diet. This is also true of other nutritious food such as meat and eggs. Since production was slow to grow, a demand-supply gap has emerged. Inflation is all about that.

What is not understood is why production has not increased in spite of the phenomenal rise in prices. Why are farmers not responding to a market that offers them huge opportunities? It is not that farmers are too conventional to change cropping patterns. They do switch production from one crop to the other depending on prices. Why then does the supply deficit continue?

There are three reasons that have together prevented the market from operating. First, the prices of fruits and vegetables fluctuate widely, making it difficult for the farmer to plan production. Second, there is no infrastructure like cold storage and a cold chain. Third, the markets are monopolized by traders. Consequently, farmers remain outside the market for the most part and are unable to take advantage of higher prices, thereby failing to make up the supply deficit.

No wonder food inflation persists. The higher rate of interest has no impact on demand for fruits and vegetables or meat and eggs. What is required is action at the farm level. One possibility is for the companies in retail to get into the loop and undertake contract farming. This presumes that the contract is made legally valid and binds the company and the farmer to contractual obligations. That will eliminate the trader, who is presently the principal beneficiary of food inflation.

But there are political pressures that make the elimination of traders difficult. It is no surprise that not many states have withdrawn the agricultural produce marketing act, which forces the farmer to sell only in the local market.

Two types of food are critically important. If production of vegetables and milk increases to catch up with demand, food inflation will drop by two percentage points from 8 to less than 6 percent.

One comment

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Panandikar has diagnosed correctly the reasons for uncontrolled inflation fueled by the shortage of vegetables, milk and fruits. Farmers do not benefit from increase in price whereas middlemen is major beneficiary of increase in prices. Production does not increase and causes infation to rise further. The middlemen belong to powerful trading community not allowing reforms to take place.

Posted by Lilahari | Report as abusive