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Lessons from economic history: Policy drivers of food inflation

Overall inflation, compared to similar previous months of FY18, has been inching up from 5.1 percent in September 2018 to 9.4% in March 2019. For the ninth month period of FY19, the average inflation stands at 6.8 percent, compared to 3.8 percent in FY18.A more dramatic increase was in year-to-year increase in Food CPI which increased from 0.1 percent in March 2018 during FY18 to 8.4 percent in March 2019 during FY19. Given that food (perishable and non-perishable) still occupies 40-50 weightage in the CPI basket for low income families, from a macro policy point of view it is imperative to identify its other remaining drivers in order to possibly dilute the ‘devaluation’ effect and weaken its transmission to the rest of the economy. A similar situation occurred twice during 1992-2006 in the country. During 92-94 it went up from10 to 16 percent and from 2 percent to 10 percent during 2003-2005.The second spike in food inflation was due to rise in international food and energy prices. Currently, it is the pass through effect of past eight months’ of devaluation and pressure on energy prices. From a policy point of view the main question of interest for managing food inflation in the short-run (i.e., 1-2 years) is the identification of policy drivers and quantification of their impact on food inflation so that policy makers can tinker around to stabilise food prices. These drivers and their impact on food inflation during 1993-2006 are documented in evidence based study, “Macroeconomics of Food Inflation” Vol.1, No.1, June 2009, NUST Journal of Business and Economics, by the present writer. The findings of the study based on the period 1993-2006 and relevant for policy makers are as follows:-

a) A 10-percent increase in growth of real per capita income (PCY) pushed the food inflation by 0.3 percent. In lay man terms if growth in PCY jumps from 4 percent to 4.4 percent, the rate of food inflation will jump hypothetically from 5 percent to 5.15 percent. One can easily call it miniscule, benign and supportive to growth dynamics. Unfortunately, as per multilateral assessments this increase in growth of PCY is not expected in the next 1-2 years. However, if growth in informal economy (believed to be equal to formal economy) is many times higher, contribution to food inflation may be significant.

b) A 10-percent increase in the index of agriculture production lowered the food inflation rate by 5.3 percent. As it is a significant driver of food inflation, policymakers need to attend to drivers such as water availability and productivity of land and labour to reduce food inflation.

c) A 10-percent increase in the growth of agriculture support prices increased food inflation rate by 5.6 percent. It more than whipped out the dis-inflationary gains of increased agriculture production. With rise of agriculture input prices blamed on devaluation, the approaching budget is likely to witness activation of agriculture lobbies in the parliament to raise support prices for wheat, basmati rice, irri and sugarcane. Unfortunately, in order to maintain its popularity, it is far easier for the government to accede to this policy measure than to increase agriculture production through structural reforms. Strong and unambiguous evidence that increased support prices lead to ‘sustainable’ increase in agriculture productivity is missing. The method of determining yearly revision of support prices need to be more scientifically based and forward looking in a longer term perspective rather than knee-jerk reaction to political lobby pressures.

d) A 10 percent increase in the growth rate of one period lagged money supply M2 increased the food inflation rate by 14.8 percent during the period. Growth in M2 is the outcome of many inter-related monetary and fiscal variables, including monetary accommodation of fiscal expansion, private credit and its end use, net foreign assets and budgetary support for commodity operations. Thus one needs to identify and assess the specific instruments of expansionary monetary policy that have the greatest impact on controlling food inflation.

e) If food inflation is the result of shortages, policymakers resort to their liberal imports. Conversely, if there is exportable surplus of food items and adverse BOT, countries also encourage exports. This also impacts the food inflation in the short-run. The model included imports index (in quantity terms) composed of edible oil, milk, pulses, spices, sugar, tea and wheat. Export index (in quantity terms) consisted of rice, fish, fruits and vegetables. In the current scenario we have exportable surplus of sugar and wheat, while fruits follow a two-way trend. Consequently, the following impacts need to be judged carefully. In the original estimation, 10 percent increase in the growth of import quantity index lowers the food inflation by 0.7 percent, while a 10 percent increase in the growth of export quantity index leads to a 0.6 percent increase in food inflation. This offsetting impact points to the ‘soft’ intervention of liberal food trade policies in these items for influencing short-term food inflation.

f) As a major export item, rice follows the law of ‘one price’. The price of broken has risen by Rs 15-20 per kg since July 2018 an increase of 21 percent, accommodating the impact of devaluation. With China agreeing to buy US $ 1 billion of rice and sugar (both in surplus at the moment), a back of the envelope calculation based on model’s estimate was conducted assuming that a) the amount would be equally divided between rice and sugar exports; b) rice exports will be of non-basmati variety; and c) rice exports to China will be in addition to the baseline rice exports of FY19. The reduced form model suggests that increased rice exports (56 percent over FY19 quantities) will add 4.3 percent to food inflation rate in the next one or two years.

Lastly, the policymakers should be aware that short-run dynamics of food inflation are far more complex. The above impacts are attributed to popular monetary and fiscal policy interventions and do not include other observable and non-observable drivers such as erratic weather conditions, including pest attacks, inaccurate crop forecasting, leakages in cross-border trade, differentials in cross-border prices, lack of storage capacity and carry-over stocks that also play into short-run dynamics of food inflation.

 

Dr Sajjad Akhtar, "Lessons from economic history: Policy drivers of food inflation," Business Recorder. 2019-04-10.
Keywords: Economics , Energy prices , Policy makers , Basmati rice , Growth rate , Export index , China , CPI , NUST

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