Saturday, July 26, 2008

Exporting hunger, importing inflation

Free economies aim at setting up markets which can adjust the demand supply mismatch and reach an equilibrium price state. But policy markers all over the world are trying to look beyond this aspect and redo the controlled model which was bared of any merits with the fall of the great eastern block. India which is among the largest democracies is the world is not far behind.

India, Vietnam, Argentina, Indonesia, Brazil, and Egypt have banned exports of various essential commodities such as wheat and rice. With commodity price rising skywards there is little support from this factor. Export ban lead to exporting hunger instead of food. Looking at the domestic scenario the countries exercising the food export ban has two motives -
a. To curb the incessant price rise and
b. To try and protect short term supply shocks

However curbing exports would not lead to lower prices of these commodities in the long term. For keeping a check on the long term price stability it is necessary to prop up production. Indian population has grown four times since 1950 and the food grain production has not grown even to that extent. India has a yield per hectare of just 2 tonnes per hectare for rice, wheat and coarse cereals taken together.

Indian poverty line (urban and rural combined according to the latest government and planning commission figures) stands and Rs. 538.10. It translates to Rs. 18 per day. The total production of rice and wheat combined is less that 14kg per capita per annum. Combined price of 250 gms of wheat and 100 gms of rice of poorest quality at market price stands at Rs.3 when uncooked. Still 22% of the Indian population is still under this poverty line. It is still debatable whether the Rs. 18 per day is above poverty line.

There is enough data that can be looked into and feeling awful of the state of the socio economic fabric of the country. Growth in agricultural production, largely achieved through increased yields since the mid 1960s, has dropped from roughly 3 per cent in the 1980s to 1.75 per cent in the first six years of the 1990s, and has continued to decline. On the demand side the calorie consumption in the rural areas and urban areas have dropped some what but the total undernourishment has risen. 40% of urban India eats less than 90% of minimum calorie needs and nearly 50% of rural India eats less than 90% of basic calorie need of 2200 calorie. Rural areas demand higher calories needs to the tune of 2400 calorie but this is fast diminishing.

The problem India is facing and which will become a major hindrance to the growth is the food scarcity. Unless the production is increased readily there is little that can be done to prevent food riots. Food crisis and riots have dominated most of the developing and under developed nations. Have a look at this graph -

pic taken from:

Price controls fail miserably in the long term and any agency trying to control prices artificially would eventually fail to do so. Since the world markets are now seeing considerable pressure from the nations which import nearly all their food needs, the right step is to open up the trade barriers and let the market decide the prices. In the short term this might be radical step but it would lead to stabilization of prices as more supply comes in for higher prices. The resource rich economies of the world are trying to impose restriction on international trade of these commodities. If these restriction were to be taken off, there would a large amount of wheat, rice corn, soybean in the markets at elevated levels. This would lead to expected fall in the prices of these commodities. In the short run it will create inflation in the regional economies, however in the longer term this would lead to lower prices. The resource economies such as Australia, China, India, Brazil etc which are rich production of certain commodities will get a boost on the revenue which can be used for development and higher production. However some of the resource economies are themselves insufficient to feed its people which is due to poor investment in agricultural sector in the last few decades. This poses as the single biggest risk to the world economy. However long term love is still love, and short term pain can lead to a long lasting solution. Resource economies need to invest heavily into agriculture to gain benefit of the rising demand which will create the self correcting mechanism and price equilibrium or bring the 'invisible hand' into play.

Since inflation posses the biggest risk presently and to this hypothesis as well, there can be a serious clamp down on the demand for goods by reducing the broader money supply. This would lead to lower demand and less of excesses in certain sectors such as housing and automobiles. However this is not entirely true for domestic economy that is the Indian economy. Indian economy faces greater threat from supply side constraints. The better idea domestically would be to first provide subsidy to agricultural sector by providing better seeds and irrigation facilities. Loan waivers would not solve the problems. A comprehensive system of presenting a stimulus by introducing a voucher system is a much better way of providing relief to the farmers. A standard voucher of certain denomination can be given to farmers. Farmers can present these vouchers to money lenders and eliminate indebtedness. It would be required to first enroll the money lenders in different parts of the country into a single institution. This would eliminate some irregularities that may emerge. most of the India farmers take loans from wealthy money lenders and not from banks. Some pay interest as high as 5% per month and depend on a single crop with Over 60% of India’s net sown area is at the mercy of the monsoon.

Energy is another important factor which is raising the inflation bar and making it difficult for India to jump it. Currently India needs 160,000 megawatts in energy immediately to sustain economic growth. The important step in this direction is to slowly and steadily increase fuel prices over time to avoid future price shocks. This would lead to rationing on its own and conservation will become a norm. Introduction of public transportation would be an added advantage. Crude oil imports in India is rising fast, latest data shows a rise of 8.4% in June over the same period last year. With government raising the tax subsidy to unprecedented levels it is keeping the pressure on the tax payers by compensating high energy consuming entities at the expense of all taxpayers. India's trade deficit widened to 10.8 billion dollars in May 2008 as exports growth slowed down and a 50.8 per cent increase in oil import during the month pushed the overall import bill.The surging oil import bill also turned India's current account balance into deficit of 1.04 billion dollars in the fourth quarter of 2007-08 against a surplus of 4.25 billion dollars a year ago.With this, India's current account deficit rose by 77 per cent to touch 17.4 billion dollars, constituting 1.5 per cent of GDP last fiscal against 9.8 billion dollars or 1.1 per cent of GDP in 2006-07.

If we expose the consumer to real prices of energy there is bound to be major economic changes with potential conflicts. Since smooth transitions are difficult we should make a choice in doing so. Atleast government should continue to raise the prices of fuel by a percent every quarter.

I think solutions lies in taking some drastic measures by the government and the central bank. The need for better economic policy and liberal monetary policy was never so urgent as it is today.

Sahil Kapoor

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