Food-O-nomics II

In my previous post, I tried to explain the dynamics of food inflation in India and touched upon the factors that influenced food prices. In this post, I plan to wrap that up by looking at what could happen to food prices if some issues are vigilantly addressed. So without wasting any time, let’s look at what these elements are:



1.    Boost infrastructure.



Initially I thought it would be a good idea for the government to start developing farm-to-market infrastructure, especially cold storage and logistics network, but then on 2^nd thoughts, I think its best that instead of government trying to do it themselves (read: scam-alert), they let specialists do it, even if with a profit motive. With FDI in (100% in single-brand and 51% in multi-brand) retail finally being allowed, it is expected that international majors interested in setting up shop in India will heavily invest in setting up “back-end infrastructure.” In fact, the new FDI rules would require them to invest 50% of their total investment (US$ 100million minimum) in back-end infrastructure, including storage, processing, distribution, warehousing, logistics etc. What these heavyweights would bring to the table is not only the much-needed capital, but also technical knowhow that might not have been possible otherwise. What would be the result of this? Higher output of-course! In due time (don’t expect miracles overnight), thanks to unclogged bottlenecks (& minimal waste), not only will the quantity of output rise, but the quality of output will see drastic improvements.

2.   Encourage education among farmers to foster innovation and improve agricultural productivity.

Encouraging more participation in farming and agriculture is another way that the government can increase supply in the food economy. The condition of our farmers (thousands of suicides every year) is known to all (partially thanks to Bollywood). But instead of blaming and criticizing the government (which seems to be in vogue these days), I simply think that if the farmers’ children are given incentives to learn modern Agriculture, perhaps on a tertiary level, then we would have this new generation of farmers who will be technologically more advanced than their parents and will become the leaders of agricultural innovation. Such a trend (on a smaller scale) is already visible in some sections of the economy where individuals are catering to the demand for organic vegetables and fruits, and other niche food items. The key take-away here is that education will lead to development and innovation, and there is a strong case for encouraging education in the agricultural sector. The Indian Institute of Horticulture Research in Bangalore, an institute of the Indian Council of Agricultural Research (ICAR) has developed new techniques of improving the quality of output. Furthermore, innovative practices that enhance efficiency and boost yields have been recommended by the ICAR but due to the bureaucratic bottlenecks, these lab-innovations could never actually make it to the farmers' fields. That being said, it is only fair that I give the government due credit for the fact that they have supported R&D in horticulture in the last 25 years by increasing the R&D budget allowance in every Five Year Plan. That support however gets negated somewhere between the labs & the fields, and as mentioned already, most of the innovations never get to see the light of day. If this broken bridge is resurrected, and more of these innovations are implemented on a commercial scale, there will be a certain boost in output, both in quantity and quality. I personally believe that cultivating education, innovation & productivity should in-fact be among the prime areas of focus for the government because it is no longer just rice, wheat and course grains that are fueling food inflation, but higher protein-based items such as fruits, vegetables, dairy, poultry and meat.


Both the recommendations above, in their own ways, lead to an increase in supply of food. Lets look at a graph similar to the one used in my previous post (Food-O-nomics) and see how an increase in supply affects the demand-supply-price dynamics of the food economy. 

As you can see from the graph, an increase in supply from S to S1 causes the quantity of output to rise from Q to Q2 and also brings the prices down from P to P2. 


It is worth noting that considering the size of India's population and landmass available to farmers, a sizable rise in output can make India a much greater player in the global food economy than what it is today. 

Food-O-nomics

For India, one of the crucial talking points of the year 2011 has been the sharp rise in food prices. So it’s only fair that I do a piece on this topic as well. However, through this piece, I would like to go to the basics, (ignore political bias and pragmatic difficulties) and look at the demand-supply dynamics in the food economy. So without further ado, let’s look at the situation we have at hand.

Since the demand and supply of food (or any other good/service for that matter) is dependent on its Price (P) and quantity available (Q), we plot a graph using P & Q, and proceed from there. Let’s say that the national demand for food is represented by the Demand Curve (D) while the national supply of food is represented by the Supply Curve (S). As we can see, D & S meet at point O, which is called the Equilibrium Point, at which the demand for food is matched by supply, and hence at quantity Q, its price is P.

For those who are already confused, let me give you a simplistic example. Assume that the demand & supply curves for Apples meet at point O, where the quantity of apples produced is 100 dozens and the price per dozen is only Rs. 20. Therefore, we can say that in the market of apples, equilibrium is at :

Q = 100 dozen      &        P = Rs. 20 / dozen 

Now using this framework, let us now see how different external events affect the prices that we as consumers have to pay for food.  

1. Government implements a rural job guarantee scheme (NREGA) which promises 100 days of employment every year to adults in rural households at Rs. 120 per day. 

Since agricultural labor prices were traditionally determined by market forces (i.e. supply and demand), they were lower than what they are now. Hence, schemes like the NREGA have artificially inflated the labor prices, which the farmers have to pay. Since the farmer only has limited funds, he has to lower other costs to accommodate the rise in labor costs, or scale down his output. Since most of the other costs cannot be lowered much further, the only alternative that remains is to lower output.

2. Poor infrastructure, & the government lacking willingness (or ability) to reform has led to severe wastage of farm output. 

Shoddy logistics, inadequate supply-chain mechanisms and substandard storage facilities have resulted in more than 30% the fruits and vegetable produce to rot before they even reach the market. All the while, the government eagerly spending Rs. 40,000 Crore (US$ 8.1 billion) on the NREGA scheme alone, and another 80,000 crore (US$ 16.2 billion) on fertilizer subsidies, but has failed to develop agricultural infrastructure. Instead of "spending" in that space, it is asking private companies to "invest" in such infrastructure. Can anyone else also see the absurdity in this scenario? At the end of the day, the implication here is simple - Loss of Output. 

Both the scenarios mentioned above have one common element. There is a fall in output because of either government action, or government inaction (don't you love such irony). Or in other words, there is a decline in the Supply of output. On the graph, this is represented by a shift of the supply curve to the left (inward shift). As you can see, with demand holing up, a fall in supply causes prices to rise. 

You can see that as the supply curve S shifts to S2, a new equilibrium point (O2) is formed where the quantity of output declines to Q2, and prices rise to P2.

I have only mentioned two examples, but there are many more issues that cause the output to fall, and a decline in supply. For instance, the Food Security Act (FSA) mandates the government to procure most of the annual grain output (and then import some more), to sell at subsidized rates. The prices are set using what's come to known as the 3-2-1 Model, where each family will pay Rs. 3/Kg for Rice, Rs. 2/kg for Wheat & Re. 1/Kg for Coarse Grain. At an estimated cost of close to Rs. 1.2 Trillion, experts are warning that the program can impact prices not just in India but the whole world. But the most imperative question at this point however is that how is the program going to be paid for and what impact is this going to have on India's fiscal deficit? 

However, what I have said so far is only a 1-dimensional view of the food market i.e.  only Supply side issues. For a diligent view, it is crucial to look at the demand side of the equation too. So let's go back to the NREGA; one consequence of this scheme has been that the rural incomes have risen leaving them with more money, which they can use to buy, among other things, more food (or some more tobacco to chew) for the household. This would increase the overall demand for food. Bear in mind that the government's Food Security Act only covers rice, what & coarse grains, and not fruits, vegetables or any meat/poultry. Hence despite FSA's exhaustive efforts, rural households will still have to pay market prices for the other food items. On the graph, this situation would be illustrated by a shift of the demand curve to the right (outward shift).

And somewhat like the last graph, observe that as the demand curve D shifts to D2, the new equilibrium point (O2) is formed where the quantity of output rises to Q2, and prices rise to P2.

I don't like repeating myself, but I have no choice except stating the obvious conclusion - government actions yet again have caused food prices to rise. Rising rural incomes may undeniably be a positive outcome, but its consequences are not. While the average GDP growth over the last 5 years has been 8.6% & the average population growth has been 1.3% (read: demand growth), the average annual growth in the agricultural sector has been a measly 3.1% (read: inadequate supply growth). An economic survey shows that post liberalization in 1991, annual per-capita production of food grains has declined 11% from 208 kg in 1996-97 to 186 kg in 2009-10.  

In my next post, I will take this discussion further and show you the solution to this predicament, and talk about measures that the government should take if it seriously wants to lower food prices in a sustainable manner.

Surprise Surprise.. Targets Missed.. Again !!

The purpose of this post is to recognize & be able to connect various dots, and draw a clearer picture of the issues that paralyzing the Indian economy. My intention is merely to instigate a desire to comprehend issues that are rooted much deeper than what we read in our daily papers. In other words, I want to raise a few themes that I believe are all inter-related and probably, the root of several problems that the Indian economy faces. 

So for starters, let me remind you of the high inflation numbers that have hurt not just the poor, but also the middle-class – perhaps more than they have hurt the poor. Traditionally, I would have gone about this by researching for CPI & WPI statistics and analyze them from that point onwards. Instead, this time I chose to simply talk to people about where they felt the pinch of inflation the most personally, just to feel the pulse of the problem. Most common areas – as expected – were food, petrol, & housing. Consequentially, their utilities bill has gone up, and savings have been dented. We will look at each of these in greater detail later.  

Now let’s leave inflation & monetary policy transmission alone for a while and look at the fiscal policy facet of our economy. Let’s begin with a special mention of the various populist schemes our government has crafted to win the hearts of the nation’s vote bank. These include the Mahatma Gandhi National Rural Employment Guarantee Act (aka NREGA), and the Minimum Support Price (MSP) given to farmers, & various subsidies on kerosene, diesel and gas, fertilizers, & food items, etc. With elections not too far away, there are more such populist schemes in the pipeline, and not surprisingly, the government has no clue of how the schemes are going to be paid for. The Finance Ministry’s had already used up 70% of the annual target of the fiscal deficit in September, and announced that it needed to borrow Rs. 528 billion. This means that while the fiscal deficit target presented during the annual budget was 4.6% of the GDP, it is more likely to be around 5.5% according to experts. However, our ever-optimistic government still maintains that they can keep it under 5%.

Furthermore, they claim that the additional borrowing has nothing to do with the fact that they have so far failed (anybody surprised?) in their plans to divest their stake in PSUs. The budgeted divestment target was Rs. 400 billion for the fiscal year, raised, primarily by issuing IPOs of the PSUs. However, globally deteriorating market conditions ruined those ambitions forcing the government to postpone their plans, and managed only Rs. 11.45 billion (not even 3% of the target). To add to the woes, slowing economic growth (especially industrial production growth) coupled with a distressing rise in trade deficit (slowing exports due to global slowdown & rising imports due to growth in Indian consumption) is surely going to result in a lower than expected tax collection. And did I mention the depreciating rupee, which has not only hurt the corporate sector (thanks to their dollar borrowings & imported inputs), but also our national kitty (oil, gold, and coal)?

Simply put, these indicators are suggesting that the government has faced a rough year since it has had to deal with lower income (missed divestment targets, declining tax revenues) but higher expenses (weaker rupee and increased subsidy spending) than it had anticipated when proposing the annual budget. Such a bleak economic picture, on both, monetary & fiscal facets, could dishearten even the most optimist policymakers. While the picture is not a pretty one, it has been painted using a brush of newspaper headlines. In my next post, I will mention some reasons why I feel India, despite its issues, is the place to be for the next decade.

Strong words for a place I have only been cynical about so far, but then again, I am a Cynical Bull !