Today's Editorial 09 October 2013

Why freeing up of food market is so crucial

Source: By Mathew Joseph: The Financial Express
Recent developments in India’s forex, capital and export markets have kindled the hope that the Indian economy is on the mend. The good monsoon this year has further boosted sentiments. Industrial output numbers from July have added more cheer to the scene. Have we reached the far end of the tunnel finally? Or is it another false dawn?

The proof for whether the Indian economy has made a turnaround depends on the behaviour of inflation in the coming months. The Reserve Bank’s recent surprise move of hiking the repo rate recognises this. India surely has not been able to contain inflation yet. The battle against inflation has been quite a long one starting right back from 2006. The average annual rate of inflation stayed high at about 7% in terms of wholesale price index (WPI) and 9% in terms of consumer price index (CPI-IW) over the last six years from 2006-07 to 2012-13.

The truth is that India has had low inflation only once during the past fifty years! And that was during 2000-06 when the average annual inflation came down to about 4-5%. The rate of inflation rose from 2-2.5% per annum in the fifties to 6% in the sixties to 8-9% through the seventies, eighties and nineties. The big risk now is whether we are moving towards the worst situation of the seventies when high inflation came with very low growth.

In India, inflation always is associated with high food prices. Therefore, the only durable way to bring inflation down is to contain the rising food prices.

Food demand-supply gap
The rise in food prices is due to both demand and supply factors. As per capita income rises, the demand for food also rises. With higher incomes, the consumption basket expands from carbohydrates to include more vitamin and protein-rich foods like vegetables, fruits, pulses, milk, fish, meat and poultry. The real per capita income in India rose by 4% per annum in the 1990s and a higher 6% in the 2000s. However, output per capita of cereals, pulses, oilseeds, and sugarcane either stagnated or increased only marginally during this period. The output per capita of vegetables, fruits, milk, fish, meat and poultry increased in India, but by much less than the rise in per capita income. Thus, there has been a widening food demand-supply gap in the country leading to high food inflation except during 2000-06.

In a free market system, a price rise elicits larger supply leading to a fall in price eventually. But in India it is not happening for food as we have an extremely distorted food market in the country. The hand of the government is everywhere in food markets ostensibly to protect the farmer and the consumer from the “exploitative” middlemen. But the acute government intervention has resulted in the opposite, leading to really strangulating the farmer on the one hand, and hurting the consumer through high prices, on the other.

Food markets in India
The current system is farmer-unfriendly in many ways. It denies the farmer of clear price signals to produce the different crops. Although the government announces minimum support prices (MSPs) for various crops, it buys only paddy and wheat (at MSPs) for the purpose of feeding its mammoth public distribution system. MSPs have been raised by 12.5% per annum for paddy and 10.3% for wheat over the last six years. Such large hikes in procurement prices combined with the massive stocking by the government itself have become the major cause of the high food inflation in the country. Besides, with a large increase in cereal prices guaranteed year after year, farmers are disinclined to go in for diversification into protein and vitamin-based food crops whose demand have been rising faster than that of cereals pushing up their prices as well.

Instead of an open free market, what we have is a “subsidy-control regime”. Subsidy is handed out by the government through free or cheap water, electricity, and fertilisers to all farmers. This has had huge negative implications on ground-water levels, soil fertility, and production efficiency of both inputs and output of agriculture. Subsidy is also offered to consumers through ultra-low pricing of cereals distributed through the government ration shops. In reality only a half of the foodgrains reaches the intended beneficiaries of the public distribution system and the rest simply leaks out.

Government control is exercised not just in pricing of inputs and output of agriculture but also in the marketing of agricultural produce. Very little reform has taken place in the agricultural produce marketing committee (APMC) regulation in various states which stipulates the sale of agricultural commodities only through the government regulated markets called the mandis. The monopsonistic mandis have been exploitative of farmers with their huge presence of intermediaries like the commission agents, wholesalers, sub-wholesalers, etc, and their nontransparent methods of weighing, pricing, payment of commissions, taxes and payments for the produce.

An important point to note here is that as the role of government in agriculture went on rising through the spread of the “subsidy-control” system, its role in investment kept on falling. The government’s share of investment in agriculture had been 40% during 1960-90 and that declined sharply in the 1990s to 24% and further to 18% in the 2000s.

Food market reform
A “root and branch” reform of India’s food markets is called for to enable the Indian farmers to produce enough to bridge the rising food demand-supply gap which is behind the persistent high inflation in the country.

The food market reform should start with the revamp of the government procurement and public distribution system. Food subsidy, while it cannot be stopped, should be given only in the form of direct cash transfers, and not through low pricing of foodgrains. The MSP system is fine but should be operative purely for supporting the farmers during price collapses, and should be de-linked from the procurement which has to be at market price.

Input subsidies to farmers also have to be administered through cash transfers and not by the low pricing of the agricultural inputs. Besides, these subsidies should be directed towards only marginal and small farmers. Simultaneously, prices of all types of fertilisers, water and electricity should be decontrolled.

Furthermore, the farmers have to be given freedom to sell their products either in mandis or to private retailers. This requires drastic changes in the APMC legislation. The recent retail liberalisation “latched with onerous conditions” will not really help, and there should free inter-state movement of agricultural products, abolition of central sales tax (CST), and a more liberal trade licensing for both domestic and foreign retailers.

Back to the '70s?
There are limits to monetary policy in controlling food inflation which is behind the long-drawn high inflation. But India cannot resume high growth without taming inflation. For that, India has to free its food markets through a radical reform. Else, the economy will be slipping back to the bitter 1970s-level.