CHAPTER 5 INFLATION IN INDIA

Transcription

1 CHAPTER 5 INFLATION IN INDIA Among the developing countries, India s record of inflation has generally considered to be satisfactory. This is because India has had a history of moderate inflation with the average overall WPI inflation rate for 63 year period, through equal to 6.75 percent. Barring few years of high inflation driven by supply shocks, inflation has remained gentle throughout the period since independence. Mohanty (2010) identifies some common threads that are seen all through the episodes of high inflation in India. According to him the causes normally include one or combination of the following: (i) war, (ii) drought, and (iii) commodity price shocks, particularly those relating to oil. In this chapter we concentrate on two important issues related to inflation in the Indian economy. First, we present a detailed outline on inflationary trends and its causes since the fifties. This is followed by a discussion on recent trends in food inflation. Finally, we present some of the policy issues that stood out significantly during the different inflationary episodes. The arguments and details discussed in this chapter are entirely based on the information and data released by various official agencies Historical Record of Inflation 29 Episodes of inflation for the last five or six decades have been short-lived and mostly attributable to fairly well identified supply shocks. Typically it was either an international oil prices causing a general spout in prices or drought conditions leading to shortage in the availability of food and raw materials (Pattnaik and Samantaraya, 2006). During the fifties the annual average decadal inflation in India was just 1.67 percent with its rate varying from percent in to 13.8 percent in The deflationary episode in was because of bumper agricultural production. But in the following years there was resurgence of inflationary pressures, mainly caused by investment demand induced by the second five year plan, together with crop failures during the three years 29 The rates of inflation, unless explicitly specified otherwise refer to year on year WPI inflation at prices. 95

2 RATE OF INFLATION Inflation in India , and at a stretch. During the sixties inflation accelerated partly due to the two wars in 1962 and 1965 and partly due to the crop failure of , when agriculture production fell by more than 16 percent. The four years from through was the first phase of high inflation because of 1965 war with Pakistan and drought in 1966 and The average annual inflation during this phase was close to 12 percent. This was apparently a market regime in which, unlike today, prices were quite flexible both ways. Figure 5.1 WPI All Commodity Inflation ( through ) WPI (AC) Source: RBI Handbook of Statistics on Indian Economy and IEG-DSE Database Inflation became a serious concern during the early 1970s when it breached the level of 20 percent in two consecutive years, and (see figure 5.1 and table 5.1). This was mainly due to the failure of kharif crops in followed by the 1973 worldwide oil shock. The annual rainfall in 1972 was only mm compared to mm received in the previous year. The domestic agricultural shock was accompanied by a sharp increase in domestic demand. During the early half of seventies the average growth rate in foodgrains production was mere 0.30 percent, whereas money supply and investment demand grew above 15 percent and 14 percent respectively. These clearly 96

3 indicated instances of excess demand building up. Along the same time, international oil prices also rose from $2.70 per barrel in September 1973 to $11.20 per barrel in September In line with the sharp increase in international oil prices, domestic prices for fuel and power (WPI- Fuel and Power) increased sharply by about 27 percent on an average during the three years beginning with through During the domestic inflation in fuel and power group was at 51 percent, food inflation (WPI- Food Articles) at 25 percent and manufactured inflation (WPI- Manufactured Products) was at 21 percent. Of course these price hikes are interlinked. The rise in oil prices also had a telling impact on the international front with India s current account deficit increasing from $450 million in to $950 million in Table 5.1 Trends in Inflation: through Years WPI-AC 30 WPI-PA WPI-FA WPI-F&P WPI-MP CPI-IW Decadal average Source: RBI Handbook of Statistics on Indian Economy. Movements in the inflation rate subsequent to the crisis period (i.e. after 1975) till about 1979 was fairly low. Inflation was negative in the year in spite of poor availability of foodgrains. This was partly due to the severe monetary and fiscal restraint 30 AC All Commodities, PA Primary Articles, FA Food Articles, F&P Fuel and Power group, MP Manufactured Products and IW Industrial Workers 97

4 that was in operation from mid onwards. Moreover, government also responded by releasing huge amount of foodgrains through PDS and open market sales to improve availability. Inflation remained low in because of good harvests in and also increased food imports. Rate of inflation rose to some extent in , due to the poor foodgrains production in , and also reduced food availability. Inflation rate fell again very sharply in the year because of the bumper crop of There was a deterioration of overall economic performance over the fifteen years 1965 through 1980, particularly in the last year of the phase. The average growth rate in GDP between was below 3 percent per annum. Inflation accelerated on account of severe drought, the doubling of world oil prices, and finally, the lagged effect of the rapid monetary expansion of the preceding years. Data reveal that in the consecutive five years preceding , the average annual growth rate in money supply was 20 percent. Also, during and , the Indian economy suffered from both internal as well as external supply shocks. The drought that occurred during 1979 was the worst since independence. Annual rainfall for the year was about 18 percent lower than the previous year. During , agricultural production fell by 15.2 percent and foodgrains production by 17.6 percent. On the international front, this year was also characterized by the second oil shock, which meant a steep rise in the world oil prices. The terms of trade declined by 33 percent during 1979 and 1980, as a result of the rise in oil prices. The drought and the disruption of fuel supplies, in turn lead to power shortages, shortages of coal and transport facilities, thus adding to the infrastructure bottlenecks that had to be built up over the years. The combined effects of the drought and the shortages of key inputs led to an industrial recession during and The rate of growth in IIP declined by 1.40 percent in There was also a steep acceleration in inflation. Rates of inflation for the period through is presented in table 5.2. Wholesale prices increased by 17 and 18 percent respectively during and A fact worth noting here is that, despite of poor agricultural production prices of food articles rose rather less rapidly than the general index in both as well as This is because government sold food stocks on a large scale during this period. During there was 30 percent increase in the off-take of foodgrains from the government warehouses. The major contribution to the price rise came from manufactured goods and fuel group. The 98

5 average annual inflation in manufactured products and fuel group was more than 20 percent during and Quite naturally owing to higher weights of manufactured products in WPI than in CPI-IW, the rates so inflation in WPI was much higher than the CPI-IW in these two years. Table 5.2 Trends in Inflation: through Years WPI-AC WPI-PA WPI-FA WPI-F&P WPI-MP CPI-IW Decadal average Source: RBI Handbook of Statistics on Indian Economy. The year 1987 was dominated by what was initially considered to be one of the worst monsoon failures on record. But in spite of this, it did not turn out not to be a serious drought. Nevertheless, the credit goes to the government for skillfully handling a second successive drought using well designed supply management. In addition, during and , there was a strong agricultural recovery, aided by good weather. But on the other side, the underlying macroeconomic position was getting worse all the while, in terms of high fiscal deficit and current account deficit. During the latter half of eighties, the fiscal deficit was of the tune of 7.66 percent of GDP and current account with deficit of 2.3 percent of GDP. Owing to all these factors, the rates of inflation remained quite high throughout the decade. The average annual inflation was close to 7 percent and 9 percent respectively in WPI and CPI (IW). In , food production rebounded, leading to a 99

6 sharp fall in the inflation of foodgrains prices in Food production continued to grow satisfactorily in and The country was lucky to have a satisfactory monsoon for the third successive year in Table 5.3 Overall Macroeconomic Indicators (Quinquennial Average of Growth Rates) Foodgrains Money Supply Deficit/GDP Period ZGDP production (M3) (Percent) to to to to to to to to to to Source: RBI Handbook of Statistics on Indian Economy. During through the country witnessed inflationary tendencies with four of the seven years with rate of price increase between 10 and 15 percent (see table 5.4). However, this episode of inflation was a lot different from the earlier ones in many ways. First, unlike in the early eighties, during late eighties as well as early nineties, owing to faster growth in services and industrial sectors, the growth rate in GDP was much higher than growth rate in the agricultural sector. Clearly, agricultural supply was not catching up with the demand. Second, for ten years, through fiscal deficit remained close to 7 percent of GDP. This itself turned out to be inflationary with near automatic monetization of deficits. Third, on the international front, with opening up of economy, there was an exceptionally large dose of devaluation of the rupee. The dollar value was first raised from Rs in to Rs in and further to Rs in This got worsened with the Gulf crisis in The crude price 100

7 which was $17 a barrel in June 1990 increased to $40 a barrel by October. Domestically this led to increase in fuel and energy prices by percent in In turn this had cost push pressures on other domestic prices. Finally one can say that inflation during this period was partly structuralist as the economy was getting adjusted to a new policy regime with primary sector taking the back stage. Table 5.4 Trends in Inflation: through Years WPI-AC WPI-PA WPI-FA WPI-F&P WPI-MP CPI-IW Decadal average Source: RBI Handbook of Statistics on Indian Economy. The second half of the 1990s was marked by a significant turnaround. The inflation rate declined from an average of 11 percent during , to about 5.3 percent during the second half of the quinquennium, The low rate of inflation during this period would partly have been due to deceleration in growth rate of money supply from 18 percent in to 16.3 percent during On the other hand, the real GDP growth also accelerated from 4.8 percent to 6.7 percent over the same period. Food articles inflation declined during the period from 12.4 percent to 8 percent. With respect to fuel and power group, the external pressures were much smaller in the latter half of nineties. More importantly there was confluence of factors which included better monetary 101

8 RATE OF INFLATION AND RATE OF GROWTH OF FOODGRAIN PRODUCTION RATE OF INTERNATIONAL FUEL INFLATION Inflation in India management facilitated by improved fiscal monetary coordination, ample food stocks, and finally, adequate foreign exchange reserves. Figure 5.2 Trends in WPI All Commodity (WPI-AC) Inflation vis-à-vis Rate of Growth of Foodgrains Production and International Crude Oil Prices since through WPI-AC Foodgrain Production Crude Oli Prices Source: RBI Handbook of Statistics on Indian Economy. In short, the episodes of inflation and its causes in the last fifty years of the 20 th century were marked by supply driven in nature. Figure 5.2 presents rate of overall WPI inflation alongside the rate of growth of foodgrains production and rate of change in international crude oil prices 31. It is clear that the sudden spikes in inflation were always preceded by either domestic agricultural shock or an international shock as in midseventies and early eighties. However, in almost all the cases the government and policy makers were quite successful in arresting these trends from persisting beyond two to three years. Nevertheless, this was at huge cost of the economic fundamentals, at times these costs further fueled inflation in the subsequent years. The increase in international oil prices and food imports to meet domestic demand will have to be compensated with huge 31 International crude oil (petroleum) price calculated as simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh, US Dollars per Barrel. 102

9 government expenditure which adds to fiscal burden. Fiscal deficit as percentage of GDP increased from 3.21 percent in to 7.66 percent during and was close to 6.30 percent during period. It is argued that swelling fiscal deficits contributed to domestic inflation during the eighties and early nineties when these deficits were monetized Recent Trends On the macroeconomic front, Indian economy entered a new phase in which the country achieved its highest consecutive five-year average growth since independence, at 8.9 per cent between and (see table 5.5). Following the good growth prospects, the overall macroeconomic indicators across sectors of the economy was showing more promise. More importantly, both WPI and CPI inflation which was a matter of concern in the previous decade eased below 5 percent in between through Fiscal deficit though it started off as 6.13 percent GDP in quickly came down to 3.96 percent in and further down to 2.54% in However, barring and growth rates in foodgrains production, a major determinant of domestic inflation was pitiably low and even negative. It is quite surprising that despite this average annual rates of food inflation was below 5 percent despite these poor harvests. On the external front, after for the first time Current Account Deficit (CAD) as percentage of GDP was positive and remained so consecutively for three years, through The surplus touched its historical best of 2.3 percent of GDP in A major turnaround of things occurred in the latter half of 2000 s when these trends not only fumbled but also had opposite signs in some cases. To start with it was inflation that cropped up domestically. Growth rate of GDP which was more than 9 percent in fell to 6.37 percent in and further to 4.96 percent in With respect to public finance, fiscal deficit as percentage of GDP went up from less than 3 percent in increased to about 6 percent in and further up to 6.46 percent in However, the deficit to GDP ratio declined quickly to 4.79 percent in However, this relief was short lived. Deficits once again increased to 5.73 percent of GDP 32 See among others, Sharma (1982), Bhattacharya (1984), Krishnamurthy (1985), Rangarajan and Arif (1990), Jhadav and Singh, (1990), Pandit (1993), Rangarajan and Mohanty (1998). 103

10 the very next year and have remained close to 5 percent in the years to follow. For the fiscal deficit stood at 4.62 percent of GDP. Moreover, along the same period, through even rate of growth of money supply increased to 20 percent per annum. This is alarming as it coincided with the declining trends in output growth. Increasing deficit and money supply should have been a clear warning signal for inflation build up. On the external front, there was depreciation in value of rupee and huge trade deficits. Unfortunately, the deteriorating domestic macroeconomic scenario also coincided with the global recession and depressing economic fundamentals. Table 5.5 Annual Growth Rates and Major Macroeconomic Indicators Year ZGDP-FC Money Supply Foodgrains production Deficit /GDP CAD / GDP Exchange Rates (rupees per dollar) Source: RBI Handbook of Statistics on Indian Economy. The early years of the century were characterized by years of low inflation barring Annual overall inflation in was more than 7 percent. This was mainly 104

11 because of steep increase in price of fuel and power for which the inflation rate was at percent. However inflationary trends softened in the following years till In annual WPI inflation rose to 6 percent fueled by fuel and power group. During this year inflation in primary articles was only 3.64 percent, whereas fuel and power group and manufactured product prices increased by 10.1 percent and 6.26 percent respectively. Once again, the domestic fuel prices was triggered by high international prices where, average monthly inflation in international crude petroleum prices was close to 47 percent during Though rate of overall WPI inflation came below 5 percent mark in the next year , the rate of food inflation was on a rise since then. The rate of WPI food inflation which was 5.42 percent in and rose close to 10 percent in The overall CPI-IW inflation too was on a rise since The annual average CPI-IW inflation which was less than 5 percent in in the early half of 2000 s was close to 9 percent during to In the recent years, the level of inflation in India has been higher than that in other developing economies (see table 5.6). This strongly suggests that domestic factors in India do have a significant role in shaping the inflationary episodes in India (Mohanty, 2010). Table 5.6 International Inflation Rates Year to to to to Brazil China Russia South Africa CPI India WPI East Asia and Pacific Europe and Central Asia World Source: World Bank Dataset and RBI Handbook of Statistics. 105

12 PRICE INDEX Inflation in India Figure 5.3 Trends in WPI and CPI since through WPI-AC WPI-PA WPI-F&P WPI-MP CPI-IW Source: RBI Handbook of Statistics on Indian Economy. WPI inflation once again fell below 5 percent in on account of mild trends in fuel and power group and manufactured prices. But rates of inflation picked up thereafter. Figure 5.3 presents trends in WPI and CPI since through CPI series is converted to = 100 to have an even comparison. Barring, the WPI-MP, there is a sudden hike in all other indices since It is important to note that the increase in WPI-PA was much steeper compared to all other prices. Obviously this was because of high food prices in the years since Compared to , rate of increase in overall WPI inflation almost doubled in with sharp increase in inflation across all the categories, especially food prices. Food inflation in was more than 9 percent annually and rates further increased alarmingly above 15 percent for the next two years and This in turn pushed inflation in primary articles into double digits for three consecutive years since to Besides the WPI food prices, average annual inflation in CPI-IW food products was also close to 13 percent for three years starting from to

13 Major reason behind higher food prices in to was once again because of poor foodgrains production. The rate of growth of foodgrains production was mere 1.60 percent in and in foodgrains production declined by 6.98 percent. Table 5.7 Trends in Inflation: through Years WPI-AC WPI-PA WPI-FA WPI-F&P WPI-MP CPI-IW Source: RBI Handbook of Statistics on Indian Economy. Both WPI and CPI food inflation in dropped significantly to close to 7 percent after two consecutive years for which it rates was above 15 percent. This of course was because of good foodgrains harvests in and which increased by percent and 5.93 percent respectively. However, these trends in food inflation and the production was not sustained in the subsequent years. Rate of growth in foodgrains production in declined by 1.52 percent and rates of WPI food inflation increased by 9.90 percent in and close to 13 percent in Annual CPI food inflation for these two years was close to 12 percent. Fortunately for the economy, in the explosive trends in food prices have eased substantially. Food inflation calculated from 107

14 both WPI and CPI-IW was around 6 percent in However, for developing economy like India, 6 percent of food inflation may be still a bit on the higher side. Moreover, in some years like , , , food inflation was high despite of good harvests. For proper understanding of these trends we need to have a detailed disaggregate analysis of various components of food prices. This will be taken up in the next section. Apart from the primary articles and food articles, even the fuel and power group and manufactured product prices increased sharply since Depreciating currency and high international crude oil could be a major reason behind the rising prices in fuel group. When rupee depreciated from rupees a dollar in to in , the rates of inflation in fuel group increased from 0.08 percent to percent in the respective years. Besides depreciation of rupee, the rate of inflation in international crude oil prices was percent in In either case, depreciation of rupee and high international prices could have added pressure on domestic oil prices. Fortunately, the explosive trends in international oil prices sharply declined since October 2008 through September 2009 and the annual inflation in international declined by percent in Owing to this, the domestic fuel prices declined by 2.15 percent in However, this comfort was short lived. Inflation in fuel and power group once again picked up momentum in and is on a rise since then. The rate of WPI inflation in fuel group was at 12 percent in and further increased close to 14 percent in Once more it was international crude prices that was the major culprit. From November 2009 to March 2012 the average monthly crude prices rose more than 30 percent. Adding to this, the value rupee also depreciated from rupees per dollar in to in and further steeply to and in and respectively. The impact of depreciating rupee on domestic fuel inflation is more prominent in and when annual WPI fuel inflation in this two years was more than 10 percent despite of 8 percent decline in international crude prices since April 2012 to May However, the impact of steadily weakening international crude prices was reflected in domestic fuel prices in when rate WPI-F&P declined by 0.94 percent. 108

15 RATE OF DOMESTIC FUEL INFLATION RATE OF INTERNATIONAL FUEL INFLATION Inflation in India Figure 5.4 Inflation in WPI- F&P and International Crude Prices WPI-FP International Crude Prices Source: RBI Handbook of Statistics on Indian Economy and the World Bank Database Interestingly, across the years we can identify that high inflation in manufactured products is coinciding with episodes of higher rates of inflation in primary products or fuel group. Where the impact of the latter is more prominent. In when inflation in WPI-MP increased to 5.66 from a 2.40 in , both the primary articles inflation and fuel and power inflation was already close 10 percent and 7 percent respectively. Further manufactured products inflation rose to 6.17 percent in and not surprisingly the primary article inflation and fuel inflation was in double digits. The very next year in the fuel group inflation was percent and correspondingly manufactured inflation also fell sharply to 2.24 percent. However, as observed earlier, since , the fuel group inflation increased rapidly along with inflation in primary articles already in double digits. This triggered inflation in manufacturing prices and it increased to from 2.24 in to 5.69 percent and then to 7.26 percent in and respectively. In the subsequent years from to , following a considerably low rate of inflation in primary articles and fuel prices, manufactured inflation also eased significantly from 5.41 percent in to 2.42 percent in

16 However, it is not surprising that these price trends are interconnected. Fuel and energy is major input for industrial production. Therefore, it is obvious that increase in fuel prices will be reflected in manufactured prices. Moreover, with exchange rate being a major determinant of domestic fuel prices, the impact of weakening rupee also may get passed on to the manufactured prices through energy prices. Besides this, there can be direct impact of exchange rate on manufactured prices through import of raw materials. Earlier, while discussing about the components and commodity wise breakup of WPI we have seen that together with food articles; minerals and crude oil also forms part also primary products. On the other hand, apart from basic metals and chemicals; manufactured food product products have the largest weight in total manufactured products. Therefore, either way through food prices or mineral prices, inflation in primary articles also will have cost push pressure on the manufactured prices. Let us now carry out a preliminary exercise on the determinants of rate of inflation (WPI) to check how far it may be explained by domestic factors and external shocks. This is done by regressing the rate of inflation on money supply growth (M3), fiscal deficit represented by deficit GDP ratio (GFD/GDP), growth in foodgrains production (QFG) and exchange rates (EX). Here, rate of growth of money supply and deficit GDP ratio could be taken as the impact of demand pressures on rate of growth of prices. Whereas, impact of changes in rate of foodgrains production could account for influence of supply side in explaining inflation. Finally, the effect of exchange rate is taken as impact of external shocks affecting domestic price movements. The equation is estimated using OLS methodology for years starting from through The stationarity of data is checked before estimation and all the variables except exchange rate is stationary at levels. Exchange rate enters the model at first difference ( EX). The estimated coefficients reflect the average shares of the respective variables in determining inflation in India. The values in the parenthesis are the t-values indicating statistical significance of the estimated coefficients. WPI = ( 2.18) QFG (2.28) EX DUM (2.08) (7.28) M3 ( 1) GFD/GDP ( 3) (1.86) R 2 = 0.65 DW statistic = 1.96 F statistic =

17 From the results one can infer that deficits, money supply, exchange rates and trends agricultural production turns out to be highly significant in explaining inflation in India. In the context of a negative coefficient for agricultural output, it is important to note that periods of high inflation in India was also characterised by poor agricultural performance which include the inflation episodes during , , , and during the late years 2000s. As mentioned earlier, this relates to the supply side determinant of inflation. Quite naturally, its effect is found to be immediate when compared to the lagged coefficients for money supply and deficit. However, important point to be noted here is the magnitude of these coefficients. It is clear from the results that the positive impact of higher money supply and deficits on inflation is much stronger that the negative impact of higher foodgrains production. This in turn point to the rising demand pressures on rates of inflation. Finally as expected, rise in exchange rates (depreciation of rupee) also have positive impact on rates of inflation. When rupee depreciate imports become costlier and this increase in prices will be passed on to domestic goods. This is importing inflation. In short one can argue that both demand and supply factors along with exchange rates are prominent in determining rates of inflation in India Food Inflation: Trends, Causes and Concerns Unlike the case of overall Inflation, food inflation has been a major concern for India for a long time. The average WPI and CPI-IW food inflation in India for 45 years since through was around 8.5 percent per annum. For the last ten years starting from , the rate of increase was even more severe, with food prices measured from both WPI as well as CPI increasing at rates close to average of 10 percent per annum. More importantly, barring a few years, all through the period the rates of inflation persisted all along. Starting from April 2005 through March 2015, for a period of 120 months food inflation was in double digits for 50 months in WPI-FA. Food inflation was at its peak in the year or rather in the late 2009 and early 2010 when its rates touched above 20 percent from December 2009 to June The average monthly inflation in and was more than 15 percent annually. 111

18 Table 5.8 Monthly Trends in WPI Food Inflation ( through ) Months April May June July August September October November December January February March Months April May June July August September October November December January February March Source: RBI Handbook of Statistics on Indian Economy. However, quite different from what has happened in the previous cases of food inflation, the current episode witnessed increase in prices despite of good monsoons and even increased foodgrains production. None of the years except and registered a decline in foodgrains production (refer to table 5.5 reported earlier). In fact, the average annual increase in rate of growth of foodgrains production, barring these two years was above 5 percent over the period through However, the trends in food inflation during this phase was quite different from what has happened in the 112

19 previous episodes of food inflation. In a sharp contrast to earlier years, the price of non foodgrains, widely termed as proteins (fruits, vegetables, milk, egg, fish and meat) increased at a much faster rate since and were alarming (see table 5.9). In and when food inflation touched 15 percent, along with foodgrains prices, the price of fruits and vegetables, milk and egg, meat and fish also increased substantially. Especially in the rate of increase in price of non-foodgrains were much faster than that of foodgrains. In fact, the rate of inflation in foodgrains declined in on account of increase in foodgrains production by 12 percent. Table 5.9 Disaggregate Trends in WPI Food Inflation ( through ) Year Cereals Pulses Fruits & Vegetables Egg, Meat & Fish Milk Source: Directorate of Economics and Statistics, Department of Agriculture and Cooperation. Though the explosive trends in non-foodgrains inflation eased substantially in the following years since , their rates of inflation on an average was still in double digits till around A common thread that connects these high priced food articles is that they are protein rich. Even among the foodgrains, it was pulses that recorded maximum increase. However, other than pulses, fruits and vegetables, none of these commodities included in the protein basket is affected by adverse monsoons. Moreover, as mentioned earlier, even foodgrains prices increased despite of reasonably good harvests. These trends in food inflation contradicts the popular notion that, food prices are always 113

20 supply determined. In the following section we categorize causes for food inflation under two broad heads namely (1) Structural factors and (2) Cyclical and Supply factors Structural Factors According to ADB (2008), Structural factors are fundamental in explaining food inflation. To quote the financial stability report released by RBI in December 2010, it says, Inflation, particularly food inflation, in India continues to rule at elevated levels reflecting in part the structural demand-supply mismatches resulting from, inter alia, rising incomes and changing consumption patterns. Non-food manufacturing inflation remains above trend. The recent upswing in food and commodity prices at the global level is also a concern for domestic inflation, going forward. In line with these arguments, Rakshit (2007) attributes food inflation to the structuralist characteristics of Indian economy. The argument is on the grounds that food articles supplied by the agricultural sector are inadequate in view of GDP growth, led by the non-agricultural sector has been high (see table 5.10). With deficient supply of agricultural commodities and food articles, a non-agriculture led output in GDP will lead to rise in demand for food/agricultural products more than what is supplied. In such a dual economic setup, supply shocks in agricultural sector will get carried over to rest of the economy, resulting in price rise in both agricultural and non-agricultural commodities, (Taylor, 1983; Balakrishnan, 1991 and Rakshit, 2007) with a sharper increase in the food prices. First, there can be cost push inflation in the non-agricultural because of increase in price of agricultural raw materials. This we have seen earlier that episodes of inflation in manufacturing sector preceded by years in which primary article inflation was high. Second, the cost push inflation in the non-agricultural sector can lead to increase in money wages and with people spending close to 50 percent of total expenditure on food, this can increase demand for food articles leading to increase in food prices. Moreover, higher wages can also add to cost push inflation. The causation that we observed from CPI-IWFA to WPI-FA in chapter 4 validates this argument. Finally, with availability of food already low because of supply shock in the agricultural sector, the resulting increase in price can be very high. 114

21 Table 5.10 Trends in Sectoral Growth and Shares in GDP through Period Rate of Growth in Agriculture Rate of Growth in Industry Rate of Growth in Services Percentage share of Agricultural GDP in total GDP Percentage share of Non- Agricultural GDP in total GDP to to to to to to to to to to to to to Source: RBI Handbook of Statistics on Indian Economy. Another way of looking at structural characteristics of food inflation is, viewing it as demand driven phenomenon with change in pattern of consumption. In Indian context, the remark made by Dr. Duvvuri Subbarao, former Governor of the Reserve Bank of India during his lecture at Cornell University, New York 33 is important. According to him Structural inflation is a problem of India s success story, specifically the growing income 33 India in a Globalizing World Some: Policy Dilemmas - presentation by Dr. D. Subbarao, Former Governor, Reserve Bank of India at Cornell University, New York,

22 of the poorest sections. Demand pressure on food prices was mainly attributed to change in consumption pattern on account of increasing affluence among the middle income people 34. Subbarao (2011) quotes the Bennet s law in explaining this scenario. The law suggests that as income increases people will substitute low protein staples with sources of high calorie, in spite of latter being expensive (trimmer et al, 1983). This explanation is similar to the Engel hypothesis which argue that with increase in income people shift consumption to superior goods. Table 5.11 Percentage Share of Major Food Articles in Total Food Consumption Expenditure Period Cereals Pulses Milk and Milk Products Rural India Egg, Fish & Meat Vegetables Fruits and Nuts Other Food Urban India Note: Other food includes edible oil, beverage, sugar, salt and spices. Source: National Sample Survey Organization In table 5.11 we have percentage share of various food articles in total food expenditure. In spite of foodgrains being staple source of food for Indians, its share in the total food basket has shown a steady declining trend. Percentage share of cereals in total food expenditure in the rural areas declined from percentage in to Kumar (1997), Radhakrishna (2005), Mittal (2006, 2008), Chand (2007), NCAER (2014). 116

23 percentage in Whereas in urban areas, cereal share in total food expenditure declined to percent in from percent in On the other hand, there is substantial increase in share of expenditure on protein rich food articles like pulses, vegetables, fruits, egg, meat and fish. The share of these items in total food expenditure in rural and urban areas has increased from percent and percent in to percent and percent respectively in A clear shift in consumption towards protein rich products. Table 5.12 Average Annual Growth in Real Household Monthly Per-Capita Expenditure Group/Subgroups Rural Urban Rural Urban Rural Urban Rural Urban Cereals Pulses, egg, milk and Fish Fruits & vegetables Other food* Note: Other food includes edible oil, beverage, sugar, salt and spices. Source: National Sample Survey Organization Growth rates in real per-capita expenditure on various food articles presented in table 5.12 reaffirms the arguments on changing consumer preference towards protein rich food articles. There is significant increase in real per-capita consumption expenditure on protein products (pulses, egg, meat, fish, fruits and vegetables combined) in both urban areas as well as in rural areas. A closer look at the data presented in table 5.12 reveals that the change in pattern of consumption is more prominent in the recent years. Compared to and , expenditure on protein products increased at much faster rates during and Interestingly, the latter half of 2000 s also coincide with the period when India achieved consistently high GDP growth rates starting from at an annual average close to 8.5 percent till about Moreover, the average annual growth rates in real personal disposable income (PDI) which was about 5.6 percent for about fifteen years since to increased close to 9 percent during

24 through Increasing share of protein expenditure in food expenditure coupled with higher growth in its real per-capita expenditure is a clear indication of growing demand for the protein products. Given these trends in increasing income and changing consumption pattern, it is not surprising that the inflation in protein products in the recent years was much higher than cereals (refer to table 5.9 for rates of inflation). This indeed strengthens the hypothesis of demand pull inflation and suggesting that possibly protein inflation has assumed a structural character with change in consumption pattern considerably driven by demand factors Cyclical and Supply Factors. However, given the fact that production of foodgrains, fruits and vegetables heavily depend on monsoons, the role of supply shocks in determining output and variations in food prices cannot be completely ruled out. Price of food articles which are mainly agricultural products are affected by factors like the cropping patterns, climatic conditions, availability of land for cultivation etc. These factors are more cyclical than structural. In India where agriculture is said to be a gamble in monsoons, one of the important causes for increasing food prices are seen as the effect of climate conditions. Adding to the problem is that the actual rainfall differs from state to state causing a skewed distribution with respect to availability of rain in different states. Finally, we must note that it is not merely the total rainfall over the year, but also its distribution over time and space as highlighted by Pandit (1978). Deficient rains can lead to increase in use of money and infrastructure on irrigation and addition to the input costs. Furthermore this can force farmers to take up risks, namely yield risk and price risk (Manendra Dev, 2011). Where the former deal with lesser yield or low productivity, the latter is rooted in price volatility and normally increasing prices. However, supply shocks arising from deficient rainfall or drought is considered to short-lived and prices are expected to decline once the climatic conditions are reversed. But trends in food production show that growth rates in food production has actually stagnated across the years. Decadal average growth rates in production of major food products are presented in table Except the case of fruits and 35 Rakshit (2007, 2011), Basu (2011a), Srinivasan (2011), Mohanthy (2011), Subbarao (2012), Gulati and Saini (2013), Agrawal and Kumaraswami (2014) and others 118

25 vegetables, rates of increase in production for all the items have declined in the following decades since eighties. Table 5.13 Decadal Average Growth Rates in Production of Major Food Articles Period Fruits and Vegetables Milk Meat Egg Fish Foodgrains Source: RBI Handbook of Statistics on Indian Economy, Food and Agricultural Organization Database and Handbook of Fisheries Statistics, Given the stagnated growth in agricultural output across the years, food production in India cannot be considered as supply shock. Rather it is a case of supply bottleneck or supply inelasticity which is endogenous and requires support mechanisms and substantial investment (Reddy, 2013). But over the years the trends in investments in agriculture sector has been disappointing. Share of gross capital formation in agriculture as percentage of total gross capital formation which was 18 percent in has fallen down to 7.2 percent in More importantly, share of public investments in agriculture has been declining. Public investment in agriculture is critical as it can significantly crowd in the private investment 36. Share of public investment in agriculture about 40 percent in the eighties has come down to a level of 17 percent in However, it may also be argued that the deficiency in public investment is substituted by private investments. But as pointed out by Mahendra Dev (2008), 90 percent of private investments in agriculture are made in non-farming sector and hence need not directly contribute to food production, especially foodgrains production. Apart from declining investments, another important factor responsible for stagnant food production could be pitiable trends in area under cultivation. Figure 5.5 presents trends in area under cultivation for rice, wheat, coarse cereals and pulses since through Clearly, the cultivated area under each of the products have remained stagnant across the time period. Area under rice cultivation which was Krishnamurthy et al (2004), Chand and Kumar (2004), Mani et al (2011), Mouges et al (2012), Mahendra Dev (2008), Balakrishnan (2014). 119