Inflation, Consumer Affairs and Public Distribution
Rising prices have been dominating discussions in the Parliament for the past few months. What has taken it's place is the rapid rate with which prices have increased recently. Yet, what is of particular importance is that this price rise comes in the face of plenty, and not scarcity as is common understanding. This brief is a compendium of perspectives on this current situation in India and other countries of the world, including developed and developing countries. In so doing, this paper should reveal how countries are inextricably linked and how each acts and reacts to the situation, in turn contributing to the global situation. Individual decisions taken in say, India, Russia or Vietnam are adding to the global crisis.
Requested by: First time MP from Tamil Nadu (Lok Sabha)
Due: April 18, 2008
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Latest Data in India
Inflation rate grew by a faster 7.33 per cent in the week ended 12th April from 7.14 per cent in the previous week, on higher prices of food items, including jaggery and fish.
The annual rate of inflation, which dipped from a 40- month high of 7.41 per cent to 7.14 for week ended 5th April, again rose despite a host of measures announced by the government to control prices.
Inflation for the corresponding period last year was at 6.34 per cent.
BACKGROUND
Rising prices have been dominating discussions in the Parliament for the past few months. What has taken the place of this discussion is one on the rapid rate with which prices have increased recently. Yet, what is of particular importance is that this price rise comes in the face of plenty, and not scarcity as is common understanding.
This brief is a compendium of perspectives on this current situation in India and other countries of the world, including developed and developing countries. In so doing, this paper should reveal how countries are inextricably linked and how each acts and reacts to the situation, in turn contributing to the global situation. Individual decisions taken in say, India, Russia or Vietnam are adding to the global crisis.
WHY ARE PRICES RISING?
A number of factors, actually, many of them global in nature but chief among them is the rise in the price of oil above $100 per barrel. Petroleum is used to make fertilizer and also as fuel in transportation so naturally when oil prices rise it affects food and other prices as well. Rising demand for ethanol has prompted farmers to switch to producing corn rather than other grains, thereby causing a shortage of soybeans, etc.
Strong growth in big, developing countries like China and India has also contributed to inflation by boosting demand for many commodities like lead, cement and steel. Moreover, industrial wages in China and service sector salaries in India have seen a huge increase, money that has been spent on imports of luxury goods, holidays and other imports. Countries like China, Russia and Middle East have spent their wealth on global bonds and are now increasing spending. Finally, weather-related problems have reduced agricultural output in some countries like Australia further putting an upward pressure on the price of wheat.
USA
The rampant demand for ethanol as fuel for American cars. In 2000 around 15m tonnes of America's maize crop was turned into ethanol; this year the quantity is likely to be around 85m tonnes. America is easily the world's largest maize exporter—and it now uses more of its maize crop for ethanol than it sells abroad.
Ethanol is the dominant reason for this year's increase in grain prices. It accounts for the rise in the price of maize because the federal government has in practice waded into the market to mop up about one-third of America's corn harvest. A big expansion of the ethanol programme in 2005 explains why maize prices started rising in the first place.
Ethanol accounts for some of the rise in the prices of other crops and foods too. Partly this is because maize is fed to animals, which are now more expensive to rear. Partly it is because America's farmers, eager to take advantage of the biofuels bonanza, went all out to produce maize this year, planting it on land previously devoted to wheat and soyabeans. This year America's maize harvest will be a jaw-dropping 335m tonnes, beating last year's by more than a quarter. The increase has been achieved partly at the expense of other food crops.
India and China
The increasing wealth in China and India is stoking demand for meat in those countries, in turn boosting the demand for cereals to feed to animals. The use of grains for bread, tortillas and chapattis is linked to the growth of the world's population. It has been flat for decades, reflecting the slowing of population growth. But demand for meat is tied to economic growth (see chart 1) and global GDP is now in its fifth successive year of expansion at a rate of 4%-plus.
Higher incomes in India and China have made hundreds of millions of people rich enough to afford meat and other foods. In 1985 the average Chinese consumer ate 20kg (44lb) of meat a year; now he eats more than 50kg. China's appetite for meat may be nearing satiation, but other countries are following behind: in developing countries as a whole, consumption of cereals has been flat since 1980, but demand for meat has doubled.
Not surprisingly, farmers are switching, too: they now feed about 200m-250m more tonnes of grain to their animals than they did 20 years ago. That increase alone accounts for a significant share of the world's total cereals crop. Calorie for calorie, you need more grain if you eat it transformed into meat than if you eat it as bread: it takes three kilograms of cereals to produce a kilo of pork, eight for a kilo of beef. So a shift in diet is multiplied many times over in the grain markets. Since the late 1980s an inexorable annual increase of 1-2% in the demand for feedgrains has ratcheted up the overall demand for cereals and pushed up prices.
WHAT ARE GOVERNMENTS DOING ABOUT INFLATION?
Inflation is a major political concern for the government because of upcoming state elections and a general election soon afterwards. The government has already taken some quick steps like trying to curb exports in sensitive commodities and reduce the cost of imports. The rationale is that exports reduce domestic supply (availability) adding to the pressure on prices; therefore the government has already banned the export of cement and non-basmati rice and may ban other commodity exports later. Similarly, cheaper imports help keep prices low and the government has reduced import duties on edible oils as well.
About a score of countries have imposed food-price controls of some sort. Argentina, Morocco, Egypt, Mexico and China have put restraints on domestic prices. A dozen countries, including India, Vietnam, Serbia and Ukraine, have imposed export taxes or limited exports. Argentina and Russia have done both. In all these places governments are seeking to shelter their people from food-price rises by price controls. But dearer food is not a pure curse: it produces winners as well as losers.
Obviously, farmers benefit—if governments allow them to keep the gains. In America, the world's biggest agricultural exporter, net farm income this year will be $87 billion, 50% more than the average of the past ten years. The prairie farmers of the Midwest are looking forward to their Caribbean cruises.
Other beneficiaries are in poor countries. Food exporters such as India, South Africa and Swaziland will gain from increased export earnings. Countries such as Malawi and Zimbabwe, which used to export food but no longer do so, also stand to gain if they can boost their harvests. Given that commodity prices have been falling for so long in real terms, this would be an enormous relief to places that have suffered from a relentless decline in their terms of trade.
Further action may be taken by the RBI: for example raising interest rates which will reduce liquidity money floating in the system -- and the total demand in the economy which will reduce the pressure on prices. Another option is to allow the exchange rate to appreciate (let rupee rise in value against the US dollar). If the rupee rises in value, imports will become less expensive which will help moderate inflation further.
Who loses?
According to the World Bank, 3 billion people live in rural areas in developing countries, of whom 2.5 billion are involved in farming. That 3 billion includes three-quarters of the world's poorest people. So in principle the poor overall should gain from higher farm incomes. In practice many will not. There are large numbers of people who lose more from higher food bills than they gain from higher farm incomes. Exactly how many varies widely from place to place.
Among the losers from higher food prices are big importers. Japan, Mexico and Saudi Arabia will have to spend more to buy their food. Perhaps they can afford it. More worryingly, some of the poorest places in Asia (Bangladesh and Nepal) and Africa (Benin and Niger) also face higher food bills. Developing countries as a whole will spend over $50 billion importing cereals this year, 10% more than last.
RELATION BETWEEN VARIOUS COUNTRIES
The crisis in the housing market has prompted the Federal Reserve to take stringent measures to tighten credit, which has taken a toll on consumption. Rising oil prices have also dampened consumption but the slowdown of the economy has been decelerated by an increase in demand for cheaper exports (given the depreciation of the dollar).
For most of 2007 Western Europe and the UK registered good growth rates of 2.6% and 3.1% respectively. Robust domestic demand was fuelled by steady employment growth, buoyant investment and strong global demand. However, these economies succumbed to surging oil prices and the appreciation of the euro which impacted real disposable income and the export market. Spillovers of the US subprime crisis have caused strains in financial markets and in the banking sector, thereby affecting European corporations which rely on bank lending more than their US counterparts.
JAPAN Japan’s economy remained resilient with a 3.5% growth rate supported mainly through exports to Europe and other Asian countries. The relatively unchanged demand from Asian economies, which now account for one-half of Japananese exports, will insulate Japan from the reduction in exports to Europe and the USA. Domestic consumption is weighed down by high fuel and food prices and sluggish wage rates.
India and China have modestly slowed but continue to grow driven by strong investment growth. Robust growth supported by domestic consumption carried Indonesia, Malaysia, Hong Kong, the Philippines and Singapore at a steady rate but these economies are now experiencing moderation following a slowing of exports. Political uncertainty and high fuel prices weighed down Korea and Thailand. However, all these countries are facing inflationary surges due to rising global food and fuel prices.
Emerging and developing economies need to be wary of inflation build-up resulting from their current high growth and should be prepared to respond to a slowdown. These countries need to walk a fine line controlling inflation while being alert to the risk of slowdown in developed economies. Countries with currencies pegged with the US dollar have less flexibility with monetary policies and will be at the receiving end of capital as a result of relatively higher interest rates. China and other diversified economies should continue to be diversified. Middle Eastern oil exporters are constrained by US monetary policy. They should aim for accounting for the cyclical nature of those economies and prioritise spending to be directed at eliminating supply bottlenecks.
Spillovers will be felt through:
1. Heavy capital inflows as a result of high interest rates
2. Fall in exports as a result of a slowdown in Europe, the USA, Canada and the UK.
Public Distribution System(PDS)
The public distribution system in India is one of the government's most important tools to fight hunger and poverty.Established in 1965, it arose from the grain rationing programs of the 1950's. While in its early years it was untargeted and mainly served urban areas, it was expanded greatly in the early 1980's so that now almost the entire population is covered by the program. A special organization known as the Food Corporation of India purchases food grains from farmers, then distributes them to state governments to sell at low prices through so-called Fair Price Shops.
The main objectives of the Public Distribution are threefold: first, to provide food grains to the poor at affordable prices; second, to support farmers by purchasing food from them at reasonable prices; and third, to maintain national food security by holding stockpiles of food. (The Food Corporation of India maintains these repositories of food grains.) Food supply is extremely important to not only the poor: food purchases account for 80% of the spending of income for the country's poor, and 60% for the rest of the population. Fair Price Shops sell at a Central Issue Price set by the government. People below the poverty line can purchase grains at half price. The public distribution program has been successful at avoiding large scale famines and starvation events through the management and distribution of food-grain supplies.
Several debates on the functioning of public distribution system have been centered on the role of public distribution system in ensuring food security or providing an adequate safety net, especially to vulnerable sections. Yet, PDS is the backbone of food security at micro level.
The PDS has been instrumental in moderating market prices and also providing food grains at assured prices at the household level. It has thus evolved as a producer-price-support cum consumer-subsidy program for more than five decades. Food grains procured by Government are distributed at subsidized prices. Besides, food grains thus distributed become the main sources of calorie supply to consumers. Hence, this sytem has close links with food security and considered as the key element of government's food security system. Based on the specific quotas, consumers with ration cards receive their entitlements through fair price shops. Though the PDS has been modified to mak it more relevant, discrepancies still exist. Some of them ate-:
1. Accessibility to fair price shops
2. Leakages and diversion of food grains
3. Budgetary subsidies not reaching the targeted poor
Evaluation of PDS: India is embarked on a program of economic reforms in 1991 with the objective of achieving macroeconomic stabilization and structural adjustment, the latter being closely tied to getting prices right. Both processes encourage government expenditure reduction and the removal of subsidies. In this context the PDS has commended considerable attention. It has been argued
that it is an obsolescent and fiscally unsustainable institution.(World Bank 1998b). These authors have also arguedthat the PDS has a poor record on reaching the poor. Hence the move towards slimming the system and targeting the subsidy at the poor. This was done in June 1997, moving through a universal public distribution system toward a targeted public distribution system. There is still a debate
on whether the PDS should be phase out and replaced with more effective instruments for reaching the poor. While the cost effectiveness of the system has been put in scrutiny, we still lack a program evaluation impact of TPDS. For that we need to investigate the benefit incidence of TPDS that is (1) access of poor to foodgrains at subsidized price and (2) conditional on the access we need to evaluate the progresivity of the TPDS with regard to poverty. That is are the poor more likely tu use PDS than others? Conditional on access does the poor benefit more in absolute term than
others?Conditional on access are the poor benefiting more than proportionately to their overall share of income or expenditure? To what extend are the impact translated into poverty variation figures4?. The poverty impact of TPDS is the difference between poverty level with the TPDS and the poverty level without it. The with data are observable while the ”without” data are fundamentally nobservable. This is the well known problem of causal inferences (Holland 1986). Common practice for assessing the distributional and poverty impact, the fiscal benefit incidence analysis, is straightforward but
ignore the counterfactual taking the transfer as the net benefit accruing to household, ignoring any behavioral responses. Benefit incidence of PDS has two component the price and the quantity the overall being the product of both. Previous evaluation consider only the with and without the program effect on prices, but fail to consider the without effect on quantities. This is to assume that those affecting by PDS does not change their consumption behavior as the result of PDS.
REFERENCES
1. http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/07/07/cninfla107.xml
2. http://www.finfacts.ie/irishfinancenews/article_1013149.shtml
3. IMF World Economic Outlook 2008
4. http://www.economist.com/opinion/displaystory.cfm?story_id=10250420
5. http://www.cek.ef.uni-lj.si
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