Inflation and Growth in India- A current perspective

The dichotomy of Indian economy characterized by poverty and inflation combined with surplus food grain stocks is due to constraints inherent in its structure.

Food grains production has continued to increase with record bumper crops recorded in recent years due to better application of high yield seeds, fertilizers, irrigation facilities and crop rotation practices. Despite high production, the Indian economy has experienced runaway food inflation at over 9%.The latest figures for WPI based inflation are 6.4%, primarily driven by inflation in food articles. Prices of wheat and rice, the staple diet for most Indians have increased steeply by an average of 80% in the last eight years. Vegetables have seen the steepest increase of about 170% during the same period.

1. Tackling Inflation

One of the major contributors to inflation is the Agricultural Produce Market Committees (APMC) Act which governs the marketing of food grains in regulated markets. This mechanism involves marketing of food grains in “yards” through a chain of eight to ten intermediaries each of whom adds his profit margin of 30% and passes it on to the consumer in form of higher prices. The Act must be substantially amended to allow farmers to sell their produce directly to buyers at the best possible prices without the involvement of intermediaries. The issue has been mentioned in the Economic Survey for 2011-12 released by the Ministry of Finance which observes that the provisions of the APMC Acts of the states stipulate that every APMC is authorized to collect market fees from the buyers/traders in the prescribed manner on the sale of the notified agricultural produce. The relatively high incidence of commission charges on agricultural / horticultural produce renders their marketing cost high is  an undesirable outcome creating high food inflation.In this context, farmers should be given the freedom to go to the APMC or not. The author strongly feels that farmers should have an alternative marketing mechanism available to sell their produce without the intermediation of the APMC act.

Though high diesel and petrol prices are also adding to food inflation, another central issue is of storage and transportation of food grains. Food Corporation of India (FCI) is the central government agency responsible for procurement, storage and distribution of food grains in the country. However, the government infrastructure and FCI godowns are not adequately equipped to store this bumper harvest leading to wastage. For instance, India’s wheat production in 2011-12 was estimated at 88.31 million tonnes but FCI’s storage capacity was 33.60 million tonnes. The problem is compounded by lack of railway wagons for transporting foodgrains cheaply and quickly across the country.  This mode of transportation is   not available to farmers who may find the best price for their produce in wheat deficient states such as Andhra Pradesh. Only big industries transporting raw materials and finished goods across the country avail this service whereby they can book wagons or an entire goods train. Alternate means available to farmers such as road transport are expensive because of numerous levies such as toll tax, sales tax and state octroi duties imposed in every state which add substantially to the cost of transportation.

The government should invite Foreign Direct Investment and encourage Indian companies to enter the freight and goods trains industry. Private companies in India cannot be expected to build railway tracks on their own because of heavy investment involved, but they can begin their goods and freight transportation services which can supplement the existing services of the Indian Railways.

A case in point is America’s freight railways which are recognized as the best in the world. The deregulation of railways under the Staggers Rail Act of 1980 transformed an almost defunct and bankrupt industry into a dynamic and profitable powerhouse. According to the “Economist”, it led to a sharp rise in traffic and productivity and fall in freight costs. Productivity has risen by 172% since 1981 after years of stagnation. Adjusted for inflation, rates are down by 55% since 1981. Rail’s share of the freight market, measured in ton-miles, has risen steadily to 43%, about the highest in any developed country. Costs of transportation have fallen in part due to higher energy efficiency. Lighter, aluminum freight wagons, double-decker ones and more fuel-efficient locomotives have lifted the number of ton-miles per (American) gallon of fuel from 332 to 457, a remarkable improvement of 38%. Americans woke up to the quiet and promising economic significance  of this sector which has been sucking costs out of supply chains when Warren Buffett’s Berkshire Hathaway purchased $34 billion stock in Burlington Northern Santa Fe (BNSF) in 2009, one of the seven main freight railways .  India has much to learn from the American experience.

The Food Corporation of India can use private companies to transport food grains across the country by paying a fee based on ton miles to be transported. Any wastage en route or delays in transportation can be fined so that these private services function efficiently. The railways could charge a nominal tariff or fee for use of its tracks by private freight train companies which could generate constant revenue stream for the government though it may add marginally to the cost of transportation. 

Private producers such as farmers in Punjab in North India could use the services of these companies for transporting foodgrains to buyers offering the best price for their produce, say in southern states such as Andhra Pradesh. Since individual farmers cannot afford to hire a railway wagon or goods train, a marketing cooperative can be formed where the cost of transportation can be shared by each member/farmer proportionate to the ton miles of crop he offers for transportation. When the cooperative would book an entire goods train, they could negotiate a discount with the company. Competition in the sector will drive down prices as these train companies compete for business with one another. Government regulation can ensure that these companies do not “collude” to fix artificially high prices or abuse their market power, which is the ability to raise prices without losing market share. In fact, rising concern about overcharging by American freight train companies has been expressed by chemical, coal, agribusiness and utility companies which raises the possibility of reregulation. Even so, American rail freight is among the cheapest in the world, costing less than half as much as in Japan or Europe and even cheaper than China after adjusting for differences in purchasing power.

This model will help to eliminate middlemen assuring a better return for farmers by putting them in direct contact with buyers in deficit states. Though the bulk of food produce would still be bought by the government through the existing mechanism at the Minimum Support Price, some portion could be marketed through this mechanism. The “e chaupal” scheme is an innovative venture launched by Indian Tobacco Company (ITC). The scheme provides internet connectivity to millions of farmers enabling them to track prices being offered by prospective buyers so that they can choose the best deal without intervention of middlemen. Mobile phone penetration in rural India has helped to bridge this information gap as farmers get quicker and more reliable information on prices of inputs and output, prospective buyers and costs of transportation. Private freight train services would perform the same function of connecting buyers with sellers. In order to have a smooth and efficiently functioning market, it is critical to put buyers and sellers in direct contact with one another so that market forces of demand and supply can determine price, output and distribution and asymmetries in information can be removed.

This model could lead to establishment of private “cash grain markets” throughout India like the Minneapolis grain exchange in the US. These markets provide a setting where buyers and sellers meet to discuss a transaction publicly or privately. The buyer and seller determine the price, quantity, quality and specific place and time of delivery.  For instance, samples of grain already loaded into railcars and ready for sale are made available to the buyer for viewing in the morning business hours. After the deal is concluded, grain is moved to the specific location by rail. The buyer pays for the grain and the seller conveys title upon delivery. Such cash transactions cover grain that is on hand, grain scheduled to arrive at a specific time, or grain that is ready for shipment from rural locations. The sellers of cash grain may be represented on the floor by an agent or broker who charges a commission for his services. Buyers of cash grain may be exporters or grain processors such as milling companies. This model can help reduce, if not eliminate middlemen altogether and work without the intermediation of the APMC act. “The Rayuthu Bazaar” in Andhra Pradesh is an example of a cash grain market where buyers and sellers meet to execute trades without intervention of middlemen. Interestingly, wheat rich advanced capitalist economies such as Canada and Australia have abolished state run marketing boards allowing multinationals such as Cargill to buy grain directly from producers. Australia abolished the state run grain monopoly, the Australian Wheat Board (AWB), in 2008. This radically changed the market dynamics as Cargill, the world’s largest agricultural commodities trader, bought AWB. Canada has abolished the Canadian Wheat Board from August 2012 based on the logic that this system would allow the coexistence of a cooperative system of wheat pooling for small farmers along with a free market controlled by large international trading houses. These companies already have a huge presence in Canada but work as agents for the Canadian Wheat Board and have established a network of silos and export terminals. Industry experts opine that the Canadian Wheat board may end up as a subsidiary of a large trading house. Though such measures are inconceivable in India, the author feels that some part of the produce could be marketed by farmers through this mechanism though bulk would still be purchased by FCI under the minimum support price. However, any storage facilities such as silos created by these multinationals would supplement the inadequate infrastructure of the government and the FCI.  The central logic underlying these exercises is to change the agriculture market from a monopsony where government is the dominant buyer into a monopolistic market with several buyers and sellers.

Another major innovation known as the “Roll on Roll off” scheme implemented by the government a few years back can work well with this model. Under this mechanism, loaded trucks roll on to a goods train and are subsequently rolled off at their destination saving time and diesel. This segment referred to as “intermodal traffic” is the fastest growing part of rail freight in the US. Big trucking companies load on containers or truck trailers to flat railcars and use road transport only for local pickup and delivery. This eases congestion on roads and is also faster and cheaper. Farmers in Punjab could transport trucks loaded with wheat, rice and other food grains to wholesale buyers in other states through this mechanism over distances which are cumbersome and expensive to cover by road. To ease traffic congestion on its tracks, the Indian Railways should embark on a major drive to expand the network of railway tracks for transportation of goods throughout the country, sometimes involving public private partnerships. Among other options, this expenditure can be partly financed through issue of sovereign debt instruments such as long term “Railway Infrastructure Bonds” with maturity period of 10 years or more. Since bonds issued by the government are considered risk free, they would be sought after by   the thrifty Indian middle class as a safe haven in choppy or volatile markets. Though bond markets are not highly developed in India, governments in advanced economies from municipalities to the federal governments frequently issue infrastructure bonds for financing development expenditure. A plan to link major ports, industrial centres and “bowls of foodgrain production”  through dedicated freight corridors to national rail routes through public private partnership can speed up intermodal traffic in India helping to remove supply chain bottlenecks.  A special rail expressway for freight in the US, the Alameda Corridor, was opened in 2002 to link ports to big national routes, and completed with public private partnership with a budget of $2.4 billion.

Current food inflation can also be controlled by expansion of private investment in the food retailing business. This not only eliminates middlemen and ensures a good price for the farmer but also allows availability of foodstuffs to consumers through an efficient supply chain such as high quality warehouses and cold storage facilities where perishable fruits and vegetables can be stored. Thus, greater FDI in the retail sector can enhance the availability of foodgrains during off or lean season to consumers throughout the country thus ensuring efficient distribution.

 Investment in the food business can also be expanded into “contract farming.” This involves direct contact between bulk buyers of fruits, vegetables and foodgrains such as big food companies and the farmers. The companies enter into a direct contract with farmers for buying foodgrains at a predetermined price and quantity. The company ensures the quality of produce by imparting seeds, fertilizers, techniques and information on modern farming methods to farmers. This eliminates middlemen allowing the buyer to source foodstuffs at reasonable prices combined with assured quality and quantity while accruing a higher return to the farmer which would otherwise have gone to middlemen.   

Inflation may also be caused due to decrease in unemployment and higher wages resulting from government sponsored welfare schemes such as The Mahatma Gandhi National Rural Employment Guarantee Act (NREGA).This scheme aims at generating minimum assured employment of one hundred days in a year at a minimum wage of Rs. 100 per day to semi-skilled and unskilled workers in rural areas.  This scheme has created a network of roads in small villages. As this program increases employment in rural areas, demand for certain goods such as basic foodstuffs and necessities increases which leads to “demand pull inflation.” Labourers employed under this programme now demand higher wages to work in small scale industrial units or on construction sites leading to “cost push inflation.” Another interesting impact of NREGA is on the textile industry in Ludhiana, Punjab through cost push inflation .A small survey conducted by Bilal Ahmad of Lovely Professional University in Ludhiana, a major textile hub in Punjab shows that the NREGA has substantially increased labour turnover in small scale textile units and led to higher wages for unskilled labourers creating cost push inflation. However, when small innovative entrepreneurs in villages use these roads built under MNREGA to transport produce into villages and small businesses begin to flourish, it can accelerate GDP growth.

The depreciation of the rupee in the last few months has pushed up the cost of importing essentials such as oil, further added to inflation. The high import cost of crude oil has to be passed on to consumers in form of higher retail prices of diesel and petrol sooner or later. State owned Oil companies have been giving an average subsidy of Rs 9 per litre on petrol and Rs 14 litre on diesel to the consumer, which may become unsustainable in the long run. Consequently, the government has announced steady increments in prices of diesel and petrol to pass some of this burden to consumers. These high prices lead to higher transportation costs and consequently higher prices of primary articles. The Though RBI (Reserve bank of India) may follow a “managed float” to support the rupee at some level, sustained intervention to check this slide would mean buying rupees and selling dollars in the open market. This may add to  “liquidity squeeze” which can further crimp borrowing by private sector, hit hard by high interest rates.

Another issue closely linked to inflation and fiscal deficit is subsidies provided on food, fertilizers, electricity, water, seeds and other agricultural inputs. The government incurs considerable administrative expenses in transferring subsidies to intended beneficiaries and there are leakages and pilferages out of the system. An alternative mechanism of cash transfers can be implemented whereby a cash transfer equivalent to the amount of subsidy can be made electronically into the beneficiary’s bank account mentioned on his Unique Identification Number (UID) card, also known as “Aadhar” card. This mechanism can help reduce leakages and also curb administrative expenses. The Economic survey proposes setting up of a Core Subsidy Management System (CSMS) for direct transfer of subsidies on kerosene, LPG, and fertilizer through Aadhar Enabled Bank Account (AEBA) to facilitate robust identification of the beneficiary. The CSMS would support all forms of direct transfers of subsidies such as non-cash transfers, conditional cash transfers, direct cash transfers etc. and would be responsive to the needs of beneficiaries, provide increased transparency, grievance redressal and real time transfer of funds.

Trying to tackle inflation through changes in interest rates is ineffective since bulk of inflation comes from runaway food inflation.  This creates a situation of high inflation combined with deceleration in output growth, which can lead to “stagflation” in extreme cases. The key to tackling the paradox of deficiency amidst prosperity in India lies in creating a better  infrastructure and electronic communication network to remove the structural constraints which hamper efficient functioning of markets.

By Chander Shekhar Dogra, Senior Lecturer in Economics at Lovely Professional University

References;

“Economic Times”, February 3, 2012

Website of Food Corporation of India

“The Economist” Jul 22nd 2010

“Economics” by Lipsey and Chrystal, 11th edition

“Economic Survey 2011-12”, Ministry of Finance, Government of India

“Macroeconomics” by Samuleson and Nordhaus, 19th edition

“Times of India”, May 11, 2012.

“Moneycontrol.com”, March 16, 2012

“Economic Times”, March 16, 2012