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Paying the price

A failed procurement programme has led to inflation which is causing concern, writes Arjun Sengupta.

india Updated: Mar 14, 2007 02:17 IST

The recent increase in the rate of inflation to a little more than 6 per cent a year has caused some concern. From 6.5 per cent in 2002-03, the average annual rate came down to 4.7 per cent in 2005-06. But from May last year, it has kept a steady upward pressure. Information about capacity constraints and over-heating may lead to a rising inflationary expectation and, without any over-reaction, some monetary tightening may be necessary for controlling that. With a GDP growth of more than 9 per cent, inflation of about 6 per cent may be quite manageable. Several empirical studies of the history of inflation have shown that if a moderately high growth rate of output is sustained, an inflation rate going even up to 15 per cent may not go out of control.

The main problem with our current inflation is the relatively high rate of price rise of wage goods of essential commodities. The foodgrain prices have increased 12.5 per cent in 2006-07 compared to 5.3 per cent in 2005-06, wheat 18.7 per cent compared to 2.4 per cent pulses, 33.9 per cent as against 13.8 per cent, potatoes 46.6 per cent compared to 10.5 per cent, fruits 9.5 per cent from 0.04 per cent. Inflation today is not much of a macro-economic problem that can be corrected with policies related to interest rates or money supplies.

It is highly unlikely that this rate of inflation will affect either the domestic or foreign rate of investment or will cause any spiralling increase of prices leading to capital flights. If policy-makers were only concerned with growth and domestic or foreign investment, they could have ignored the recent spurt of inflation. But the UPA government came to power on an explicit platform that they would not allow the welfare of the common man to deteriorate.

Inflation in the essential commodities directly affects the purchasing power of the common man. The government has to take action to arrest such inflation even if its macro-economic impact is not large. The policy to control the price of these essential commodities can hardly be restraining the demand for these products by controlling credit or money supply. The common man has very little to spare to increase his demand. The problem has to be resolved almost entirely through supply management, by expanding the supply of these commodities in the market.

The medium term approach to such supply management has to be increasing the production of these essential commodities, raising their minimum support prices and ensuring their distribution through markets and public distribution. However, in the short term, when no further increase in production or procurement is possible, inflation of essential commodities will have to be reduced by expanding the public distribution system (PDS) and increasing the supply of these products.

For any tradable product, supply is made up of domestic production and net imports. If there is a shortage in domestic production, imports must increase to match the domestic demand. For essential commodities, all importable, adequate imports would arrest price increases that have been caused either by shortage in domestic production or by traders holding stocks to create further shortages. The challenge is to work out an import programme, well in advance and ensure the release of the goods in the domestic market in such a manner that they do not affect the incentives of farmers to expand production and that supplies are available to the common man throughout the country.

In India, we already have such a policy framework in the form of using buffer stocks and the PDS. There are three elements of that framework. First, there has to be a mechanism to estimate the buffer stock requirements for the medium term, projecting the increase in domestic demand and domestic production. This would complement yearly short term projections based on information about sowing and the area under production. Second, there has to be a programme for domestic procurement and minimum support prices as well as net imports of the commodities, entering the international markets at an appropriate time, having contracts for forward delivery as necessary, without shooting up the global price. Several Indian public agencies, such as the Food Corporation of India (FCI), the State Trading Corporation (STC) and the National Agricultural Cooperative Marketing Federation (Nafed), have developed enough expertise in such trading. Many private traders also could do that — provided they were sure that domestic prices would be high enough to cover the cost of imports.

The third element of this policy is related precisely to the point that the government cannot allow prices of essential wage goods to rise very high and depend on private trade to increase supply in the domestic market. There may not be much problem if the global prices are much lower than the domestic prices, in which case an open general licence (OGL) for imports by private traders may be sufficient to maintain the supply-demand balance. But when the global prices are high, we have to depend on public sector agencies to import as cheaply as possible and then supply to the domestic market at predetermined issue prices that have to be subsidised.

A buffer stock policy would imply an advance planning of import, which will be held by the FCI or other agencies, either domestically or through rolling on contracts internationally. The cost of such holding and releasing them at issue prices low enough to have a dampening effect on the domestic market even at a loss will have to be borne by the government. It is not very different from the current policy of procurement at minimum prices from the farmers and holding them until these are issued in the different markets at predetermined prices and the government taking up the losses in this operation as subsidies. The buffer stocks would be the only addition to these stocks, held for controlling the domestic prices when the normal procurement and distribution policies cannot check the rise in prices.

In such a policy framework, failure in supply management can be attributed to (a) failure to ensure a procurement programme with right support prices and an efficient PDS, and (b) a failure to import goods at the right time, at the right prices. In January last year, the buffer stock of cereals showed a substantial shortage. The global market price of wheat at that time was the lowest when the government should have entered the market with large purchases to be delivered over a period of time. The government entered the market in a piecemeal manner and contracted for imports — though not in adequate amounts, at higher prices at later parts of the year. Naturally, the cost of such imports became higher, increasing the subsidies.

To control that, the government reduced the allocation in the PDS, especially for those above the poverty line, even if they are poor by all counts. As a result, domestic prices went up even higher with rising price expectation resulting in further hoarding by private traders.

That the prices of pulses would go up significantly was foreseen by mid-2006, as all projections showed substantial shortfalls of production. The government stuck to its policy of private imports — with an import duty — instead of asking agencies like Nafed and STC to go in for imports in large quantities. International prices kept rising largely because of expectations of a large future imports from India. Only recently the government has withdrawn the import duties and has asked some public sector agencies to go in for imports offering them a 15 per cent subsidy. The market is very tight now and the import prices will be much higher. This increased cost of subsidy is very largely due to the mismanagement of import policy of the government.

There is no shortage of foreign exchange in India today, and the government cannot afford a continuous rise in the prices of essential commodities. So it has to import even at high international prices and release it through the PDS at subsidised prices. The cost of the subsidies have gone up and will continue to go up, until the next season, when the domestic price of these goods start coming to the market.

Arjun Sengupta is a Rajya Sabha MP and a former member secretary of the Planning Commission