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Joseph Mariathasan: Dealing with India’s food price volatility

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As India continues to dismantle rigid controls on its economy, the private sector is booming. A new generation of entrepreneurs is arising that can challenge the traditional dominance of the old conglomerates that grew in size during the period of the “license raj”, the bureaucratic system that ran from 1947 to the early 1990s.

One sector that still suffers tremendously from rigidity and vested interests, which act to the detriment of society as a whole, is Indian agriculture. While the agricultural sector of India’s economy accounts for less than 20% of its economic output, it is still India’s largest employer. As such, it is a core component of the economy.

A major problem that afflicts the agriculture sector, however, is the high volatility of food prices. When prices are high, consumers protest, and when they are low, farmers suffer badly and ask for loan waivers. Proposed solutions to this volatility could be transformational for farmers and consumers – and, ultimately, investors.

There are structural reasons why food price volatility occurs within any local region. A typical example is a year in which sugar cane output is high, causing a price crash. As a result, producers pull back from allocations of land and agricultural inputs, which in turn leads to a decline in output, leading to a further surge in prices, and so the cycle repeats, giving rise to an endless cycle of boom and bust in food prices.

There are several approaches to address this problem that could be created or aided by public policy, including:

  • The creation of futures markets, bringing visible tradeable future prices and helping production decisions by ensuring future prices are fixed;
  • Warehousing where possible, enabling sales to be shifted across time to create a better equilibrium between supply and demand, helping to stabilise prices; and
  • International trade, enabling surpluses to be exported and – when required – imports to address shortages, stabilising local prices.

Finally, India’s size makes it a continental economy with different production shocks across the country. Unfortunately, India’s domestic market in agricultural produce is currently restricted by a set of archaic laws that keep food markets uncompetitive and localised. Moreover, state and sub-state taxes effectively act as technical barriers to the free movement of agricultural food products.

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A recent paper by four academics at the National Institute of Public Finance and Policy in New Delhi suggested that one solution would be to introduce a national market for food.

(One of the authors, Ajay Shah, was a key author of a 2000 report on social security, which led to the creation of India’s National Pension Scheme. Given the pedigree of the authors, it is worth taking their suggestions seriously.)

The authors point out that, in Indian agriculture, large changes in prices are required to obtain the required changes in quantities produced of any food commodity. This points to rigidities in the economy through which small price signals are ineffectual.

Their core question is: how does India move to a more flexible and responsive agricultural market that is able to respond to changes in demand with modifications in output without requiring extreme price fluctuations?

They argue that there are two specific problems which prevent the creation of a national market for agricultural food products. Firstly, legal restrictions placed by states are so high that it is not commercially feasible to enable a national tradeable marketplace. Such restrictions benefit cartels of buyers within a state, encourage corruption and result in slow movement of grains from surplus to deficit regions, giving rise to price variation across regions.

Secondly, there are other state laws (primarily on taxes) that require so many technical compliance requirements that physically moving goods across markets is extremely difficult.

India should move towards dismantling restrictions preventing a national market in food produce. The authors suggest creating a statutory body to identify technical barriers to agricultural trade within India and require them to be dismantled.

Secondly, the national government could use its powers under India’s constitution to remove monopolies and punitive provisions under existing laws, and replace them with a modern regulatory framework conducive to the growth and operation of a national market in agricultural food commodities.

For investors, if the paper’s recommendations are implemented, it would create a whole new set of opportunities in a major sector of India’s economy.

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