Why low food inflation may not be good for India?

Is there a cost involved to keep inflation this low?

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India’s annual retail inflation touched a record low of 1.54% in June 2017 bringing cheer to the market. According to the numbers released by Central Statistics Office (CSO), retail inflation on the consumer price index (CPI), was dragged down by a sharp fall in the prices of the food items that included vegetables, pulses, and other perishable goods. The current rate of food inflation is at the lowest, ever since the series was introduced in 2012.

The retail inflation in June has gone southwards as compared to 2.18% in May 2017 and 5.77% on a year-on-year (Y-o-Y) basis, according to CSO data.

However, these encouraging numbers have brought up a very pertinent question – Is there a cost involved to keep food inflation this low? A clutch of grassroots evidence suggests that the data of rock-bottom inflation could be an indicator of an unstable economy in the near future.

The current free fall of the food inflation rate can chiefly be attributed to a bumper winter crop season that has led to well-stocked food grains in the local markets. With the supply outnumbering demand, farmers are compelled to dump their produce at dirt cheap prices to clear the rising stock of vegetables before they perish. This is evident in the falling food inflation numbers, which is nothing but a proxy for measuring how cheap or expensive commonly consumed food items have become.

The demonization done on 8th November 2016 left the farmers with little elbowroom to negotiate crop prices with the wholesalers. It may have been possible that the wholesalers used the pretext of demonetization and squeezed the cash outflow to farmers with a “take it or leave it” attitude. This possibly acted as a fait accompli for the farmers who had to get rid of their stock of food grains and vegetables at whatever price they got.

According to several sources, onion and potato cultivators were the worst hit. The country’s horticulture output touched 295 million in the 2016-17 fiscal and outstripped the food grains production for six years on the trot.

The minimum support price (MSP), where the government buys crops from farmers at a certain base price, is not applicable on onions, potatoes and vegetables. The MSP system is supported by the state and acts as a cushion to cut farmer dependencies on private wholesale buyers. MSP is a minimum floor price that farmers are guaranteed to get, even if there are plenty of harvests and falling market rates.

Although agricultural activity contributes only about 14 percent to the country’s GDP, income from farming indirectly influences the factory output. For instance, one in every three TV sets manufactured in the country is sold in village and semi-urban areas, and nearly 40 percent of the demand for cement in the country is generated from the rural housing.

But the latest data on factory output shows that there is hardly any production of goods. A key pointer to industrial activity and shoppers’ mood, factory output was merely 1.7 percent in May. That’s depressing, to say the least.

The Reserve Bank of India (RBI) has started monitoring something called “sacrifice ratio”. This is the ratio of the loss of output that must be sustained to achieve a reduced trend inflation. The ratio is statistically defined as the percentage loss of real output sustained to one percent reduction in the trend inflation, and highlights the facts that forcing down inflation below a certain level involves a cost. The social cost of decreasing food prices is not exclusive of this.

In a nutshell, falling prices owing to falling food prices is adversely affecting the purchasing power of the farmer community, which in turn is impacting the consumption in the rural and semi-urban areas, which could result in lower production output at the manufacturing sector. And none of this can be good for India in the long term!

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