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Rate hikes and rising food prices

posted Nov 1, 2011, 5:18 AM by Puneet Goyal   [ updated Nov 1, 2011, 5:19 AM ]

Dr D. Subbarao, Governor of the Reserve Bank of India (RBI), is in a Catch-22 situation. If he doesn't raise interest rates, he stands accused of doing nothing to tame inflation. But if he does raise interest rates, his ability to control inflation, as the general public sees it, is rather limited. As can be seen from the graph below, the increase in interest rates by RBI hasn't necessarily resulted in an easing of inflation in past few years in India.

The Wholesale Price Inflation for September 2011 stood at 9.72 per cent. Fuel and Food, which together comprise 22 per cent of this index, have been a major reason for the increase. Fuel and Power inflation increased to 14.09 per cent, due to Rs 3.14-rise in the price of petrol on September 1, 2011. Food inflation was at 10.6 per cent in the week ending October 8, as against 9.32 per cent in the week before that, providing no relief to the aam admi.

Interestingly, food forms nearly 14 per cent of the Wholesale Price Index, and increasing the interest rates simply isn't the solution to controlling the food prices. There are several reasons for this.

First and foremost, rural India is eating better. This is primarily because of a surge in rural income. As analyst Akhilesh Tilotia of Kotak Institutional Equities points out in a report titled ‘This Time is Ripe', the total income in rural India has gone up by 138 per cent to Rs 6,81,400 crore during a five-year period ending in 2009.

It need not be said this is primarily because of the Mahatma Gandhi National Rural Employment Guarantee Scheme, which has led to a significant flow of money into rural India.

Over and above this, the United Progressive Alliance is getting for the next Lok Sabha elections with the introduction of the Food Security Bill. The Bill is currently up for discussion and draft guarantees food to priority households i.e. those below the poverty line, as well as other poor families who have been classified as ‘general households'. This move if and when it goes through is expected to drive food prices up all over the world, because of the sheer numbers (population) that we have.

There are other problems as well which will continue to drive food prices up in the years to come. A report brought out by DWS Investments suggests that “dramatic increases in the irrigation of crops across northern India have substantially depleted the region's groundwater. This would mean lesser water for irrigation across the Gangetic plain which produces a major part of the grain that India consumes.”

Grain and food production is also threatened by other long-term factors. One is the continued expansion of some of our biggest cities at the cost of taking over agriculture land. As environmentalist Mr Lester Brown writes in Outgrowing the Earth: The Food Security Challenge in an Age of Falling Water Tables and Rising Temperatures, “As a country industrialises and modernises, crop land is used for industrial and residential development.Secondly, as rapid industrialisation pulls labour out of the countryside, it often leads to less double cropping.”

In fact the world is running out of land for agriculture. The world renowned hedge fund manager Mr Jeremy Grantham explains this in his newsletter titledTime to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever, “Only Brazil, and perhaps the Ukraine, has really large potential increments of output. Elsewhere, available land is shrinking. We have, though, had impressive productivity gains per acre in the past, and this has indeed helped a lot. But, sadly, these gains are decreasing.”

What also does not help is the prospect of higher atmospheric temperature.

Crop ecologists use a rule of thumb that for each 1-degree-Celsius rise in temperature above the optimum during the growing season, we can expect a 10-per cent decline in grain yields.”

As Brown points out “In India, the giant Gangotri Glacier, which helps keep the Ganges river flowing during the dry season, is retreating. The Ganges is, by far the largest source of surface water irrigation in India.”

Many of the above factors are already translating into almost doubling the Price of Food Index, Dhaanya, at NCDEX, the leading agricultural commodities exchange in the country.

The factors are way beyond the control of Mr Subbarao and he cannot do anything about it by increasing interest rates. So, will his interest rate hikes bring down the inflation rates? We doubt!

(The author is a Post-Doc Fellow, Indian School of Business, Hyderabad. The views are personal.)