Has RBI realised that food inflation cannot be tamed through repo rate hike alone or is it just a onetime phenomenon? Whatever be the RBI stance, let us look at some interesting facts

The Reserve Bank of India (RBI) has surprised the stock market by not increasing repo rate at a time when almost every banker and analyst felt that repo rate hike was a foregone conclusion. This expectation came in the wake of recently released retail and wholesale inflation data. Retail inflation was at 11.2% and wholesale price index (WPI) number touched 15 months high, which was too high for comfort. Vegetable prices went up by more than 60%. With this persistent or sticky inflation as RBI often refers inflation as, it was very obvious that RBI would increase repo rate. Endorsing RBI approach to tame food inflation through monetary policy measures, one of the newspapers wrote in its editorial, “It is incorrect to assume that food inflation cannot be dealt through monetary policy, a blunt tool that affects overall demand.” The RBI realised that food inflation cannot be tamed through repo rate hike alone or is it just a onetime phenomenon and in the next policy RBI will increase repo rate in next policy? Whatever be the RBI stance, let us look at some interesting facts which clearly show that food inflation cannot be effectively controlled through monetary policy measures.
 

It is an open secret that demand for food products is inelastic by nature and does not vary with increase in price substantially unless price hike is very steep. Any attempt to curtail demand through tightening of money supply measures will not work effectively is for sure. If demand side cannot be managed by monetary policy measures should is it that supply side constraints are increasing the price of food products as the price of food items depend on demand and supply. The answer is a firm NO.

Let us look at some data here:
 

Source:RBI ( In million tones)
 

From 2002-03 to 2012-13, foodgrains production in the country has gone up from 174.38 million tonnes to 255.36 tonnes. This is a significant increase, good enough to take care of increasing population and increasing demand as a result of this. On supply side, we are on a strong wicket as well. So then where does the problem of inflation originate from?
 

The analysis of the problem requires looking at three critical factors and several ancillary factors which have been fuelling inflation in India.
 

The first is the minimum support price of the foodgrains which have been in upswing for some time now.
 

The second critical factor is the increasing wages, especially the rural wages.
 

The third, and final, factor is a combination of international factors coupled with depreciating rupee which has added fuel to the fire.
 

Apart from these factors, other factors which have caused food price hike recently are hoarding as in case of onion price, bad supply chain management in context of movement of goods etc.
 

Let us look at the first factor which is increasing support price of foodgrains the data of which is given below:
 

(Rupees per quintal) Source:RBI

The data shows that there has been a steep hike in procurement price over a period of last eight years. When support prices double in a span of eight years in paddy and wheat and increase more than three times of ‘Urad’, then how can we expect price to remain stable. This is not to say that farmer should not be given benefit of higher procurement prices, but once the minimum support price has been increased, how can inflation remain low. These prices become in a way minimum base price. We have to learn to live with higher rate of inflation. Another argument could be is higher procurement price reason of inflation or vice versa. This can be analysed in context of what is going on in case of sugarcane crushing in Uttar Pradesh and Maharashtra. Sugar mill owners refused to crush sugarcane because of ever increasing minimum support price of sugarcane price at the state level.
 

The second most important factor of increasing wage rates which has fuelled inflation in India. Let us look at the data to believe it:
 

With this kind of wage hike, how can food inflation remain in control? Please remember that jump in rural wages have direct impact on foodgrains consumption. With an average 13%-14% in minimum wages, rural population has acquired beyond imagination purchasing powers during recent years. Can monetary policy control this aspect of rural wage hike? The wage hike had a spillover impact on other sectors as well. Urban wage has gone up as well. Now, imagine with 7^th Pay Commission recommendations coming up, another set of salary hike is obvious. The idea is not to criticise these hikes but to analyse how monetary policy can control this.
 

The third factor which is causing food inflation to go up is the crude oil price. Food inflation sensitivity to crude oil prices, especially diesel price is well known. The depreciating rupee, increasing crude prices internationally and government attempt to deregulate crude oil price has stoked inflation. In 2013, diesel price has gone up by Rs6 per litre. We are lucky that international crude oil price has remained stable recently, otherwise crude oil prices would have gone up even more. We are lucky that diesel consumption has gone down in India after a long time in the current year, but the question remains is whether it is sustainable. If government continues to deregulate diesel price, we cannot skip inflation for next one year atleast and even after that international price movement of crude oil will decide inflation in India.
 

Other factors causing food inflation such as hoarding and supply chain management issues cannot be controlled by monetary tightening. It is well established that prices of onion went up because of structural issues and not because of money supply. The RBI measure to increase inflation in the past has only retarded growth. The RBI needs to understand that even if inflation comes down in near future, it may be because of factors such as better supply of foodgrains post-kharif crops. Given the policy measures adopted by the government during recent years, it is better that we learn to live with new normal inflation or rethink our policy measures. Monetary policy measures will remain largely ineffective in controlling inflation is well established now.
 

(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)