The Hindu Business Line : Inflation and deteriorating terms of trade for agriculture

Commodity prices may be rising but have not benefited the producers. For farmers the terms of trade have been worsening. The solution lies in an efficient marketing system.

The Government is facing a piquant situation with some sections complaining of rising commodity prices, leading to an inflationary situation and farmers carping about low prices for their products.

In reality, if one party benefits, the other must lose. However, in this case, neither party seems to be benefiting, and it has been a lose-lose situation.

The Centre adopted various measures to contain prices during the last few months when the debate on the rising prices of essential commodities was raging within and outside Parliament. While some of these measures were direct in nature, others were indirect. The indirect measures included resort to fiscal and monetary instruments.

Relaxing supply-side pressure

However, regulatory measures taken so far have been oriented towards relaxing the supply-side pressures on the agricultural commodities such as the reduction in import tariffs, etc; these are also considered direct measures.

The difference in these measures is implicit in the responsiveness of the market to them. A change in the Customs duty is done to immediately augment the supply side and thereby hasten the response time rather than adjusting the interest rates at which the trade shall get credit from banks. While taking these direct measures, the Government had felt that the relaxation of supply-side pressures would dampen inflationary expectations by augmenting supplies in the commodities market.

However, these measures failed to have the anticipated impact due to the global market conditions. Though the Government has reduced the Customs duty, in some cases making it zero, the required quantities could not be imported any cheaper as the prices of many commodities in the global markets were high due to fundamental factors. Indirect measures include fiscal policy by the Government and the Monetary Policy by the Reserve Bank of India to ensure that less money chases fewer goods, thus reducing demand-pull inflation.

Rise in inflation

In fact, the RBI raising the benchmark interest rates was mainly to control the excess liquidity in the market, which had pushed up real-estate prices and could have raised commodity prices, thus fuelling inflation.

The inflation story is really a tale of what comes first, chicken or egg — that is, whether the inflationary pressures are driving the commodity prices or the commodity prices are causing the current inflationary trend.

A closer look at certain commodities would reveal, for instance, that the prices of sugar and wheat were managed by the Government through various market intervention mechanisms, thereby affecting the physical market's role in effective price discovery.

Moreover, trade in these commodities operated in an asymmetrical information situation from both the supply and demand sides. Hence, market operations based on this lack of information could only benefit segments that were privy to the available information. Unfortunately, in the existing agricultural market ecosystem, consumers have no say as the entire marketing system revolves around the traders and to some extent the producers. Hence, both consumers and producers are often at a loss. It thus makes sense to explore ways to empower them. Usually, traders build in a heavy margin to compensate for the physical and financial risk of carrying the commodity, short or long term.

Further, many traders who operate on a low scale normally do not borrow and, therefore, undertake small operations, which require large number of intermediation before goods can move from the farmgate to the consumer's plate, resulting in higher margins. The mark-up at every stage pushes up the final price without benefiting the producers.

Situation of farmers

The situation of the farmers has got aggravated with the prices for their produce not matching that of other commodities, especially the farm inputs.

The higher inflationary expectation due to a rise in commodity prices is evident from the Wholesale Price Index . The WPI moved up at a much steeper rate than the commodity prices over the last five years indicating deteriorating terms of trade for the agricultural sector, that is, farmers received prices lower than what their counterparts from the other sectors did, in relative terms.

The prices of other primary commodities — minerals, diesel oil and fuel, power light and lubricants — went up significantly. This disparity affected the agricultural sector in two ways. First, it had a restrictive effect on investments in farming, affecting production efficiency.

Second, falling/stagnant agricultural commodity prices, on the one hand, and increasing prices of agriculture inputs and other daily life commodities, on the other, led to a deterioration in the standard of living of the farmers.

Further, the cost payable by the consumer is impacted by the cost of living of the entire value chain, which thrives on the inefficient markets; this adds to the final cost of the material. For example, high energy cost itself has contributed to the increase in the cost of inputs required for agriculture besides pushing up the marketing costs of farm products.

Information symmetry

A solution to the lopsided terms of trade for agricultural produce vis-à-vis other primary produce lies in developing markets that function based on symmetry of information with the participants and transparent enough to warrant the efficient assimilation of the prices discovered in the physical market.

That is, a national online electronic commodity exchange, which in modern terms stands for equitable participation at the lowest possible cost, effective risk management, and efficient price discovery.

The wholesale prices discovered in major agricultural commodities have increased either due to fundamental factors or due to the efforts of the commodity exchanges to provide correct economic value to producers.

In the process, the markets are also likely to witness improvements in in terms of better warehouses, storage practices, grading, and standardisation.

This would further increase efficiency in the marketing mechanism thereby improving the functioning of the physical marketand its infrastructure, making it cost-effective.

Such an efficient system can reduce the cost of marketing essential agricultural commodities thus translating into better prices for the consumers, even as the terms of trade improve for the producers. This can be the only way to create a win-win situation for both the consumers and the producers.

(The authors are Chief Economist and Economist respectively of Multi Commodity Exchange (MCX) of India Ltd. The views are personal.)

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