The WPI (Wholesale Price Index) inflation for the month of August reveals the biggest headache for the new RBI Governor, Dr. Raghuram Rajan. The WPI inflation printed at 6.1% for August 2013, up from levels of 5.79% seen in July 2013 and 5.16% seen in June 2013. June inflation was revised upwards from first estimates of 4.86%.
Rajan will have to balance out protecting the INR from sustained fall, rising food prices and falling aggregate demand in his policy stance. To a large extent the INR fall to record lows against the USD is contributed by rising food prices and falling aggregate demand. Food prices trending higher are largely due to the policies adopted by the central and state governments. RBI policy review on the 20th of September should reveal the thought process of the governor.
WPI data for August 2013 reveals that Primary Articles Index with a weight of around 20% in the index rose 11.72% in August 2013 and food articles with a weight of 14% in the primary article index rose 18.18%. Vegetable prices has risen by more than 100% since March 2013 and despite having a lower weight of around 3.5% in the index, has contributed heavily to the rise in primary articles index.
The manufactured products index with a weight of around 65% in the WPI rose by just 1.9% in August 2013. Non food manufacturing index too rose by 1.9% in August 2013, indicating the dichotomy between food and manufacturing inflation.
Various reasons are given for the rise in food prices. Monsoons, MSP (Minimum Support Price), Transportation Costs, Speculation etc have contributed to the rise in food prices. It is expected that post October 2013 when the South-West monsoons retreat, food prices will collapse on a bumper harvest. Given the sharp rise in prices over the last few months, prices are bound to come off post October but looking at long term averages, food prices have gone up multifold and are likely to trend higher going forward.
The reason food prices will continue to trend higher in the long term is the Government, both Central and State. The central government has just passed a food security bill that guarantees food supply to the needy while it has been running a rural employment scheme that guarantees employment to the needy.
The state governments are busy giving freebies such as gas, television and laptops to the lower earning section of the population. Electricity is subsidized, food is subsidized and the centre guarantees employment.
The central and state governments have made sure that there is absolutely no incentive for anyone to work the fields. The most common complaint amongst farmers in India is the lack of labour and the cost of labour. Why should anyone work hard in the fields when the government is providing everything free?
The fact that agricultural land is more productive when sold is adding to the high food prices. Farmers who till land find it more profitable to sell the land to the government or the private sector that is engaged in infrastructure projects or industrial activity. Productive land is given up for commercial use leading to fall in agricultural production.
The government is forcing the farmers to sell land for commercial purposes by giving them money. However the farmers are not being offered land elsewhere to carry on farming. There are no clear estimates to the loss of agricultural production due to diversion of land for commercial purposes but its all adding up to higher food prices.