We can cope with drought

A glance at the rainfall statistics indicates that monsoon till now at all-India level has been well below the normal. As per the forecast of Indian meteorological department, El nino, a shift in the ocean temperatures that disrupts the usual weather pattern, is expected to set in by the end of August. This means much of the rainfall must happen between now and mid-August. Under these circumstances, the fear of another drought is rising with each passing day.

In case there is a drought, then besides stepping up agriculture-related expenditure, one of the biggest worries for the government would be — how to maintain food price stability.

Fortunately, last season witnessed a record foodgrain production of over 250 million tonnes and the stock of foodgrain available with the government agencies as on July 1, 2012 is estimated to be 80.5 million tonnes, out of which 49.8 million tonnes is wheat and 30.7 million tonnes is rice.

The foodgrain stock level is well above the buffer plus strategic norms of 31.9 million tonnes prescribed by the government. This should provide government the comfort that country has enough foodgrains to tide over any crisis.

COMPARING TWO DROUGHTS

But will government be able to stop foodgrain inflation from flaring up? Let us look at the two recent episodes of drought – 2002 and 2009. In both these years, acreage and output of the foodgrains declined from the previous years.

While the acreage and output in 2009 declined by 1.2 and 7.0 per cent, respectively, the same declined by 7.3 and 17.9 per cent in 2002. Clearly, the decline in 2009 — both of acreage and output of foodgrains — was significantly less than the decline witnessed in 2002. Even in terms of per capita output, the situation in 2009 was better than 2002 (Fig 1). Yet, the prices of foodgrains in 2009 escalated much more than 2002 (Fig 2).

What drove the prices high in 2009? It appears that despite having adequate foodgrain stocks, the government did not intervene in the market as effectively as it did in 2002. As a consequence, hoarding coupled with speculation played a key role in escalating prices in 2009.

The retail mark-up over wholesale prices corroborates this. The gap between retail and wholesale prices on account of transactions costs plus margins is expected to remain stable over time, and any sudden/abnormal movement between the two could be indicative of an increase in hoarding and speculation. The retail mark-up over wholesale prices increased sharply for all the three commodities – wheat, rice and pulses (tur) from March 2009 to March 2010. While in the case of wheat it increased from 9.2 per cent to nearly 11 per cent, in the case of pulses (tur) it increased from about 7 per cent to 9.4 per cent.

MSP’S CONTRIBUTION

Another factor that pushed the food prices up in 2009 was the steep rise in the MSP (Minimum Support Price) of foodgrains.

While MSP for wheat shot up from Rs 800 per quintal in 2006-07 to Rs 1,080 per quintal in 2008-09, the MSP for common rice increased from Rs 620 per quintal to Rs 900 for the same period.

This translates into 37.5 and 61.3 per cent increase in MSP of wheat and rice respectively in a span of three years, which was unprecedented. As MSP fixes the floor price, the wholesale/retail price never falls below this level, irrespective of the supply situation of the agricultural commodity in question.

For rice, the correlation between MSP and retail prices was 0.768 during 1996-2003 but went up to 0.943 during 2004-2011. Similarly, for wheat the correlation has gone up from 0.553 to 0.975 for the same period.

This shows that the retail price has become even more sensitive now to the movement of MSP than it was during 1996-2003.

The MSP of rice and wheat for 2012-13 has been increased to Rs 1,250 and Rs 1,350 per quintal, respectively. Over the price of 2011-12, this is an increase of 15.7 per cent for rice and 5.1 per cent for wheat.

The Commission on Agricultural Costs and Prices (CACP), which recommends the MSP to the government, says that in the recent past there has been a sharp escalation in the cost of production of agricultural commodities, and therefore to keep farmers incentivised, there is no choice but to raise MSP.

PRODUCTIVITY CONCERNS

However, at the core of the rising MSP is the stagnation in agricultural productivity. There is an inverse relationship between real cost of production and productivity i.e., as productivity goes up, real costs come down.

Therefore, a prudent response to ever increasing costs of production lies in enhancement of agricultural productivity, otherwise pressure on MSP to rise in accordance with the cost of production will continue.

Drought or no drought, the increase in MSP for 2012-13 will reflect in the retail prices going forward. However, in case of drought, how much more prices of foodgrain would rise would depend on how well and effectively government uses the available foodgrain stock to intervene in the market and contain hoarding and speculative activity.

If a contingency plan, therefore, is ready well in advance, it would go a long way in mitigating the adverse consequences of drought on inflation.

(The author is Director and Principal Economist at Crisil Ltd. The views are personal.)

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