In January 2014, the Reserve Bank of India formally adopted a ‘glide path’ for achieving a consumer price inflation (CPI) target of 8 per cent by January 2015 and 6 per cent by January 2016. Tight monetary policy has reined in headline inflation from 9.8 per cent in September 2013 to 6.5 per cent in September 2014 as measured by consumer price index (CPI combined). But fruit and vegetable prices have remained stubbornly high. Food price inflation declined from 11.8 per cent to 7.7 per cent over the period but fruits and vegetables rule high at 22.4 per cent and 8.6 per cent, respectively.

Food constitutes about 48 per cent of the CPI and plays a significant role in retail inflation. As observed in the September 30 monetary policy report, food price shocks have large and persistent effects on inflation expectations. This extends to prices of non-food items, contributing to overall inflation. Fruits and vegetables, which constitute a mere 8 per cent of the inflation index, continue to contribute significantly to headline inflation. In India, food inflation has stayed very high over the last decade, especially in the case of vegetables. While the Government has intervened heavily in the markets for cereals, pulses and edible oils, the prices of vegetables fluctuate tremendously.

Our data analysis from 2005 onwards reveals that variations in acreage and yields have contributed to erratic supply of vegetables. Production is vulnerable to weather shocks, and due to inadequate infrastructure for cold storage drying, is immediately transmitted to markets in terms of price rise.

Vulnerable areas

The key vulnerable commodities are potatoes and onions based on our analysis of the last 13 food price shocks --- incidences when the percentage increase in the food inflation index was more than 3 per cent of the previous month’s index. Potatoes figured nine times and onions seven times in this analysis.

To illustrate, onion is cultivated all over India but nearly two-third of the production comes from Maharashtra, Madhya Pradesh, Karnataka and Andhra Pradesh. India is the world’s second largest producer of onions though it lags behind world average productivity. As a percentage of total production, nearly one-tenth of the onions are exported. However, since last year, India has been importing onions.

Generally, hoarding is blamed for price fluctuations. The crop’s cultivation has a specific cycle, and to maintain year-round availability, farmers, traders and middlemen are compelled to store these commodities. Contrary to general belief, storing happens at each level of the supply chain, including the farmer. From the farmer’s perspective, if the current wholesale price is too low, it makes business sense to wait for it to rise and then sell it in the market. Of course, there is a trade-off: the longer it is stored, the more water and weight it loses, reducing overall revenue, not to mention the added warehouse or cold storage rental expense. Often, farmers do not harvest the onions until the prices are favourable, but they run the risk of spoilage and sprouting.

Pricing loopholes

Currently the process of dissemination of prices is informal. The farmers/traders contact the commission agents in a particular mandi and fix a range of acceptable prices. If the commission agent does not achieve that price for one day, the stock is sold the next day at the best available price.

This system reflects gaps in the transmission of price information to farmers. The potential for agents’ collusion in the determination of prices could hamper the revenue potential for farmers. The Government’s initiatives to control prices can be grouped as domestic price regulation; intermittent bans on exports and minimum export price regulations; controlling import duties for onions; and storage initiatives by National Agricultural Cooperative Marketing Federation of India Ltd (Nafed), and the Central and State warehousing corporations. The need is to adopt measures to accurately forecast demand and supply of onions and develop a robust agricultural marketing system.

To anchor expectations and stabilise prices, Nafed procures onions under the market intervention scheme on an ad hoc basis. A new scheme incorporating minimum support price could be considered. Finally, there is a need to formalise updating and dissemination of information to farmers through an internet database. Streamlining agricultural markets would help ease the pressure on monetary policy The RBI can then manage the demand side through interest rates without supply side concerns.

Singh is RBI Chair Professor of Economics, IIM Bangalore. Pal and Shah are IIM-B students

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