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Jul 16, 2017 11:40 AM IST | Source:

Here’s why low inflation may not be a good sign

The current deflation in food prices appears structurally different from earlier glut years. Demonetisation may have weakened farmers’ elbow room to negotiate better prices with wholesalers offering a “take or leave it” offer in mandis

Gaurav Choudhury @gauravchoudhury

India’s inflation rates have slowed to record lows and food prices have been falling, implying household kitchen budgets have come down compared to a year ago.

Latest price data released Friday showed that wholesale inflation slowed to 0.9 percent in June, the lowest in a year. It was 2.17 percent in May.

Consumer price index (CPI)—commonly referred to as retail inflation—also moderated sharply to 1.54 percent in June, the lowest since the index was rebased to 2012 in a new data series.

But a clutch of evidence from the ground suggest that price data on falling prices, which should otherwise be a matter of rejoice, could be a marker of a wobbly economy.

The current price crash is partly due to a bumper winter-sown crop that have flooded mandis. With few buyers, the glut has forced farmers to dump products at throwaway prices to clear up a piling mount of vegetables.

This is showing up in food inflation, a proxy to measure how costly or cheaper commonly consumed items have become on an annualised basis, has declined sharply.

Retail food and beverage prices have fallen for the second straight month— (-) 1.17 percent in June and (-) 0.22 percent in May—indicating declining shop-end prices for most edible items.

Wholesale food inflation rates too mirrored similar trends, falling (-) 2.27 percent in May and (-) 3.47 percent in June, signs that farmers have been selling their produce to bulk traders at prices lower than the previous year.

The deflation in food prices this year could, however, be structurally different from earlier glut years. The sudden flush out of high-value notes may have weakened farmers’ elbow room in mandis this year to negotiate better prices.

It is quite likely that bulk buyers used demonetisation and restricted cash as an alibi to give farmers a “take or leave it” kind of offer in wholesale markets, offering a fait accompli of sorts to get rid of vegetables that would otherwise perish.

Potato and onion farmers have been worst hit. India’s horticulture output rose to 295 million in 2016-17, outstripping food-grain output for the sixth year in a row.

Vegetables, potatoes and onions do not attract minimum support price (MSP)—where the government purchases crops from the farmers at a certain assured price. A state-supported MSP mechanism acts a cushion, cuts the dependence on private wholesale buyers, and helps fix a minimum floor price that farmers are almost guaranteed to get even if markets are swamped by an abundant harvest collapsing mandi rates.

Sample this. Wholesale potato prices, which fell (-) 47.12 percent in June, have been in deflation zone since December 2016. Vegetable prices, which fell (-) 25.47 percent in June, have also been falling since the last one year.

Wholesale onion prices have now been falling for more than a year—it fell (-) 9.47 percent. This is in sharp contrast to 2014, when price of the popular bulb used in most Indian curries, skyrocketed to more than Rs 50 a kg at wholesale markets as weather shocks and suspected speculative hoarding by traders pushed up prices.

Pulses, a common source of protein for most Indians, have seen a significant fall in prices from two years ago, when unseasonal hailstorms damaged crops across major lentil growing states. In 2015 arhar or tur dal prices had retailed at more than Rs 200 a kg.

A string of measures including a higher MSP by state procurement agencies and greater imports bolstered supplies, helping bring down retail prices to about Rs 80 a kg currently.

A higher MSP, however, incentivised farmers to shift to pulse cropping, resulting in a glut and lowering market prices.

Although, agriculture accounts for only about 14 percent of India’s GDP, farm income influences activity in millions of factories. For instance, a third of television sets are sold in rural markets and 40 percent of India’s cement demand comes from rural housing.

Latest data show factories are barely producing more goods.  Factory output – a good indicator of both industrial activity and mood of shoppers – crawled at 1.7 percent in May.

The manufacturing sector, which accounts for 75 percent of total factory output measured by the index of industrial production (IIP), fared even worse, growing at 1.2 percent during May. Weak industrial activity lead to other adverse impacts, such as job cuts and less pay. A strong manufacturing sector on the other hand creates jobs.

In times of weak growth and low prices, it is usually expected that the central bank will cut interest rates to spur companies to invest, hire more, and prod people to spend more.

The RBI and the government has set a retail inflation target of 4 percent for next five years with an upper tolerance level of 6 percent and lower limit of 2 percent.

Such an approach now become standard international practice in many mature economies, such as Britain, where the central bank sets interest rates according to an inflation target that the government sets.

High inflation hurts people’s buying power, while low levels can indicate poor demand and weak economic activity.

The government has been unequivocal in asking the RBI to cut rates next month. Retail inflation is at its lowest in many years, and industrial growth at just above 1 percent. The RBI, the argument goes, should cut lending rates that will lower borrowing costs and boost spending and investment.

“Clearly this low (inflation) number and what it implies about underlying price pressures…is something that I am sure, will all policy makers will reflect upon very, very carefully,” Arvind Subramanian, Chief Economic Advisor, said on Wednesday.

While the RBI may oblige, there is still the supply side problem the government has to deal with, which might require adding, quickly, at least 50 million tonnes of additional cold storage to preserve perishables during gluts.
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