The Hindu Business Line : The revival in agricultural growth

At a time when there are signs of a slowdown in industry, much is being made of an agricultural revival that is helping to stabilise India’s high growth rate. But C. P. Chandrasekhar and Jayati Ghosh argue that, despite somewhat high growth rates of agriculture in recent years, a longer term perspective suggests that all is still not well in a sector that has been damaged in India’s post-reform growth trajectory.

Statements from government spokespersons and policymakers have suggested that over the last three to four years, the long-term, post-reform tendency for agricultural growth to lag behind industry and services has been reversed.

If this is true, it is indeed an important development, because one factor that was taking the sheen off the higher growth of the 1990s and after was the extreme disproportionality in growth between the agricultural and non-agricultural sectors.

The disparity in the rate of growth of agricultural and non-agricultural GDP increased significantly after the 1970s, with the process being particularly marked after the mid-1990s.

For much of this time, the government’s resort to imports of agricultural commodities in individual years, the changes in the input dependence of industry on agriculture and the lack of responsiveness of employment and real wages to increases in non-agricultural production meant that this disproportionality did not lead to sharp increases in agricultural prices, as happened in the 1960s, for example.

However, more recently, agricultural prices, especially of food, have begun to respond to the inadequate expansion of supply. Interestingly, this has occurred most in the years when an agricultural revival has reportedly been redressing potential shortfalls in supply relative to demand. This does raise questions regarding the strength and nature of this so-called revival.

One piece of evidence that supports the view that the differential in agricultural and non-agricultural growth rates is being redressed, is that on the rate of growth of GDP in Agriculture and Allied Activities.

While the rate of growth of GDP in this sector was just 2.9 per cent over the period 2000-01 to 2007-08 as a whole, it stood at 5.9, 3.8 and 4.5 per cent respectively over the three years ending 2007-08.

Production figures

However, to get a clearer picture of the performance of the agricultural sector, it is useful to turn to the actual figures on agricultural production. Figures on the annual rates of growth of production in different categories of crops for the last four years are presented in Table 1. There are a number of trends that these figures reveal.

To start with, in the case of all important crops, the rates of growth in individual years have been extremely volatile, with high growth occurring in particular commodities in very different years. Volatility was particularly marked in coarse cereals, which have been poor performers for some time.

Second, the average increase in production over the period 2003-04 to 2007-08 was low for almost all important crops excepting sugarcane and cotton.

Third, the revival in agricultural production holds largely for a few non-foodgrain crops, especially cotton and sugarcane, and not in foodgrains, which is one area where the recent inflation in prices occurred.

Thus, the agricultural revival reflected in the aggregate figures on agricultural growth is partial, and does not redress the fundamental weakness that has characterised post-reform growth in India.

These conclusions are broadly supported by medium term growth trends, as reported in Charts 1-3. As Chart 1 shows, the trend rate of growth of foodgrains production has been the lowest in the first eight years of this decade when compared with rates during the previous two decades.

It is in cotton that the revival in production during this decade has been sharp (Chart 2).

This is in keeping with the food and non-food distinction made above, though there has been a revival of production in oilseeds as well (Chart 3).

Given the evidence that the ability of the system to “accommodate” the disproportionality between agricultural and non-agricultural growth is now waning, this pattern of growth is of relevance.

The extensive literature analysing the relationship between agricultural and non-agricultural growth in developing, mixed economies in general and India in particular points to multiple ways in which slow agricultural growth can constrain the non-agricultural sector.

First, with the agricultural sector accounting for a substantial share of non-residential GDP, demand from the agricultural sector is seen as crucial to sustaining the demand for non-agricultural products and services, especially manufactured products.

Second, since agricultural commodities constitute a significant share of input costs in some industries and of the wage basket in most, increases in agricultural prices can affect industrial production.

In particular, if an industry is agro-based or characterised by a tendency for money wages to rise with increases in the prices of wage goods, it can experience an increase in costs that may not be neutralised by an increase in final product prices. In the event, profits could be squeezed and manufacturing investment affected adversely.

Third, increases in agricultural prices can constrain the growth of demand in the manufacturing sector as consumers allocate a larger share of their incomes to food consumption and a smaller share to manufactures demand.

Finally, this effect is intensified if the government reduces public expenditure to reduce absorption and dampen price increases.

Increases in agricultural prices resulting from any disproportionality in agricultural and non-agricultural growth may force the government to act in this fashion, leading to a reduction in the direct and indirect (through employment and income generation) demand for industrial commodities.

This constraint on demand growth also adversely affects the ability of firms in industries producing mass consumption goods to raise prices in order to cover higher costs.

Transmission mechanisms

These different ways in which agricultural performance was expected to affect non-agricultural growth were predicated on the operation of two transmission mechanisms.

First, increases in non-agricultural growth were expected to result in increases in the direct (inputs) and indirect (wage goods) demand for agricultural products.

Second, since agricultural growth was seen as constrained from the supply side, any disproportionality in industrial and agricultural growth was expected to result in an abnormal increase in the prices of agricultural goods, since those prices were largely determined by the relative levels of supply and demand.

Seen in this light, recent trends in agriculture may be relaxing the agricultural constraint on non-agricultural growth that comes from the input side, especially in the case of industries such as cotton textiles and sugar.

But the constraint set on non-agricultural growth by the slow growth of production of items that enter the food basket may now begin to bite, as witnessed by the effects on industrial production, stock market sentiment and profits of the recent buoyancy in food prices.

The reason why this had not yet asserted itself in full is because the government had succeeded in containing agricultural price inflation to some extent, through the mechanisms described earlier.

Eroding control

As Chart 4 shows, the terms of trade between agriculture and non-agriculture, which moved against the former during the second half of the 1990s, have been more or less stagnant during the first half of this decade. This is despite the fact that agricultural growth had fallen substantially short of non-agricultural growth.

This decline and stagnation in agricultural terms of trade explains the declining financial viability of crop production. But the more recent evidence, as yet to be captured in the official terms of trade figures, is that the ability of the government to keep down agricultural prices — and food prices in particular — is fast eroding.

Such erosion, expressed in unacceptable food price inflation, would challenge the complacency associated with the perception that we are seeing an agricultural revival. This should lead to greater policy attention to actually improving agricultural performance, as happened after the crisis in the mid-1960s.

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