Column: Supply constraints or market failure?

May 01 2014, 21:14 IST
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SummaryMarket imperfection is most probably failing to transmit adequate price signal to farmers

Food inflation has been haunting India for nearly a decade now, averaging 12.2% in the last five years alone. It is concerning that even an 8.3 percentage point drop in nominal income (per capita) growth since FY11 helped sober overall food inflation to just 11% monthly over April 2010-March 2013. In FY14, it shot up to 13% each month, on average, notwithstanding that nominal income stagnated while agriculture grew an outstanding 4.6%!

Why do food prices refuse to come down? Why do farmers not grow even more? The dominant view is that ‘supply-side constraints’ are inhibiting output response, to which other problems add. But the faster acceleration in prices of other foods, relative to cereals or staples, questions if the major faultline might be market failure—if support-prices distort the market for cereals, a free-pricing mechanism operates for non-cereal foods. Why then is production not responding to this shift in relative prices? Can supply-constraints be such a barrier in this age of information flows? Or, must we examine if price signals are actually reaching the farmers?

As a backdrop, consider the various hypotheses explaining food inflation. The recently articulated view by RBI (Fighting Inflation, Governor’s speech on February 26, 2014) identifies the primary driver of food inflation as “growing prosperity” accompanied by “dietary shifts”; the latter, in particular, applies to prices of protein-rich, high-value foods. Other identified drivers are: minimum support prices (MSP) for key cereals and pulses, but quite justified by input price increases, especially fertilisers, fodder, cattle feed and rural wage growth; floor and indexation effects of the MGNREGA, but which only account for a small proportion of wage growth and whose effects are on the decline now; rural liquidity and credit effects of higher bank lending and land sales; labour shifts from agriculture to non-agriculture sectors, especially construction; and possible effects of declining female labour participation rate.

How has production responded to these demand-side developments? By all accounts, agriculture performance has been outstanding over this period. The sector’s growth averaged 3.6% annually over 2007-2012 (Economic Survey, 2012-13), more than a percentage point above the preceding decade’s average growth rate. Private investment grew an average 12.5% each year in 2007-11; its share in the total capital formation in agriculture rose nearly 10 percentage points until FY09, stabilising at 82% since. Fruits and vegetables output grew 6% on average each year in the last decade, while per capita availability rose some 50%;

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