Measuring Food Inflation in India

Any price index can in principle be calculated using producer, consumer, or wholesale prices, with each serving a different purpose. The producer price index measures the average selling prices received by domestic producers of goods and services. This contrasts with other inflation measures, such as the consumer price index (CPI) which measures average prices from the consumer’s perspective. Seller and consumer prices may differ; for example, due to taxes, subsidies, and distribution costs. The wholesale price index (WPI) ideally measures average prices in the wholesale market; that is, where goods are sold in bulk. These price indices are used to measure the average change over time in selling prices received by producers (producer price index inflation), or prices paid by consumers (CPI inflation), or the average price change in the wholesale market (WPI inflation).

The WPI is historically the most commonly used price index for measuring inflation in India.² However, the term “wholesale” is misleading in that the index does not necessarily measure prices in the wholesale market. In practice, the WPI in India measures prices at different stages of the value chain. As discussed in Srinivasan (2008), based on the National Statistical Commission, “in many cases, these prices correspond to farm-gate, factory-gate, or mine-head prices; and in many other cases, they refer to prices at the level of primary markets, secondary markets or other wholesale or retail markets.”

The weights used in the WPI are revised every decade. The latest series is based on 2004/05 as the base year, and includes 676 commodities. Figure 3.1 shows the weights used in the WPI: food’s total weight is 24.3 percent, of which 14.3 percent is for primary foods and the rest for processed food. Fuel’s weight is close to 15 percent. In the nonfood, nonfuel category, the three largest weights are chemicals (12 percent), metals (10.7 percent), and textiles (7.3 percent). The WPI does not include services.

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Wholesale Price Index Weights

(2004–05 = 100)

Source: Ministry of Commerce and Industry.

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As well as the WPI, four consumer price indices are also officially published. These correspond to different segments of the population: industrial workers (CPI-IW, base year 2001), agricultural laborers (CPI-AL, base year 1986–87), rural laborers (CPI-RL, base year 1986–87), and urban nonmanual employees (CPI-UNME, base year 2001). A nationwide measure of CPI that combines rural and urban areas became available in January 2011 (base year 2010). The weights used for the new CPI are derived from the 61st (2004–05) round of the National Sample Survey.³ The CPI-IW includes only six subindices: clothing, food, fuel and lighting, housing, tobacco and intoxicants, and miscellaneous. CPI-AL and CPI-RL are published with only five subindices and exclude housing.

The commodity coverage for the latest CPI measures has been broadened, and includes 23 items. In addition to housing, six subcategories of services are included. Importantly, the CPI gives a much larger weight to food compared to the WPI (Figure 3.2). The weight on food in the CPI ranges from 46–69 percent, depending on the segment of workers the index refers to, and hence is more likely to capture the recent surges in food prices after 2005.⁴ The CPI is arguably a better measure than the WPI to study changes in prices of final goods demanded by consumers. The analysis in this chapter, however, relies largely on the WPI, because the CPI is not available at a disaggregated commodity level (even the most recent nationwide index is much more aggregated compared to the WPI). Wherever possible—for more aggregated trends—the CPI is also be used.

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Consumer Price Index Weights

(2001 = 100)

Source: Ministry of Commerce and Industry.

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Several papers point out the deficiencies of the price indices used in India for measuring inflation (for example, Srinivasan 2008). Recommendations to improve the indices include converting the WPI into a producer price index and expanding the scope of both the WPI and CPI to include services. The CPI, even in its latest incarnation (2010 as base year) has limited coverage of goods and services (total of 23 items), and hence is not amenable to any serious disaggregated analysis. Therefore, if the CPI were to become the primary index for policy purposes (as is the norm in most countries), expanding its coverage beyond a mere 23 items is imperative.

We use WPI data at the monthly frequency, covering July 1988 to February 2014. The WPI index (2004–05 as base year), with 676 items (112 food items), is only available from April 2004. To create one comparable series for the WPI over 1988—2011, we project the 2004–05 series backward using the growth rates in the price indices based on the 1993–94 series (covering 435 commodities) and 1981–82 (447 commodities) series. Although we confirmed that using either series does not significantly change the trends in overall inflation, caution should be exercised in comparing aggregate inflation trends based on the changing basket of commodities over time.

The food price index can be specified using the following formula:

where $I_{jt}^F$ is the price index of the jth food item at time t, $W_{j0}^F$ is the weight assigned to the jth food item in the food price index (not the overall price index). The weight of the jth food item is given by

where $W_{j0}^F$ is the expenditure on the jth food item calculated using base-year prices and quantities.

The top 25 food items with the highest WPI weights are shown in Figure 3.3.⁵ Inflation is calculated on a year-over-year basis. Although food and fuel prices may show similar dynamics, the focus of this chapter is on food prices; hence we exclude fuel. The term “nonfood” denotes the items excluding food and fuel.

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Top 25 Food Items with the Highest WPI Weights

(2004–05 = 100)

Source: Ministry of Commerce and Industry.Note: WPI = wholesale price index.

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Broad Trends in Food Inflation

In this section, we examine the behavior of food inflation and its relationship with nonfood and aggregate inflation. The goal is to systematically document stylized facts about the importance of food in inflation, using some descriptive statistics.

There have been three peaks of food inflation in the past two decades—1991, 1998, 2010—when average annual year-over-year (calendar year) inflation rates reached 17.9 percent, 11.1 percent, and 14.2 percent, respectively (Figure 3.4). Indeed, if we look at the peaks of monthly year-over-year inflation reached during a given year, the three peaks were higher—20.8 percent in 1991, 18.1 percent in 1998, and 20.2 percent in 2009–10 (Figure 3.5, panel 1). Panel 2 presents the number of months for which food inflation was higher than nonfood inflation. In most years, for the majority of months, food inflation has been higher than nonfood inflation. We will look closely at the contributors to food inflation in the latter two peaks, but the lack of disaggregated commodity-level data on prices prior to 1994 precludes a deeper analysis for 1991.

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Inflation Rate: Food and Nonfood

(Percent)

Source: Ministry of Commerce and Industry; and authors’ calculations.Note: This figure shows the average year-over-year inflation rates based on the wholesale price index. The trends are estimated based on a Hodrick-Prescott filter, with a smoothing parameter of 100.

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Behavior of Food and Nonfood Inflation

Sources: Government of India; Ministry of Commerce and Industry; and authors’ calculation.Note: Panel 1 shows the peaks in any month in a year for the year-over-year inflation rates based on the wholesale price index (WPI). The WPI figure for 2011 is based on January–May; for consumer price index, from January–April. Panel 2 uses year-over-year inflation rates based on the WPI. The index figure for 2011 is based on January-May.

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Domestic and International Food Prices

How integrated are domestic food prices with their international counterparts? In this section, we make a first pass at this question, which has become particularly relevant since the global food price crisis in 2008. We find only a moderate correlation between domestic and international food prices (close to 0.5), as panel 1 of Figure 3.6 shows.⁶ Yet, at the commodity level, variation in the degree of comovement between domestic and international prices is significant (shown in Table 3.1). In general, the relationship is weaker for staples like rice and wheat compared to, say, edible oils and sugar. This may reflect, in part, the government’s reluctance to allow any significant pass-through from international to domestic prices of staples, as discussed in detail in the section on short-term factors. But broadly, the degree of comovement depends on the actual or potential tradability of the commodity.⁷ Highly tradable products like edible oils therefore exhibit a high degree of comovement between domestic and international prices.

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Relationship Between Domestic and International Cereal Prices

Source: IMF, Commodities database.Note: Panel 1 shows the evolution of world and domestic food prices. The world prices are for 13 food items; domestic prices are based on the wholesale price index and are a weighted average of the 13 items for which the world prices exist.

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^{Table 3.1}

Correlation between Domestic and World Food Price Inflation

Source: IMF, Commodities Database. Note: The database covers 13 food items. The domestic food price inflation is based on a weighted average of the wholesale price index for the same 13 items.

^{Table 3.1}

Correlation between Domestic and World Food Price Inflation

Overall	0.47
Rice	0.14
Wheat	0.30
Maize	0.15
Sugar	0.62
Edible oils	0.88
Chicken	0.32
Fish	0.55

Source: IMF, Commodities Database. Note: The database covers 13 food items. The domestic food price inflation is based on a weighted average of the wholesale price index for the same 13 items.

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^{Table 3.1}

Correlation between Domestic and World Food Price Inflation

Overall	0.47
Rice	0.14
Wheat	0.30
Maize	0.15
Sugar	0.62
Edible oils	0.88
Chicken	0.32
Fish	0.55

Source: IMF, Commodities Database. Note: The database covers 13 food items. The domestic food price inflation is based on a weighted average of the wholesale price index for the same 13 items.

Another interesting and consistent pattern that emerges across commodities is that the degree of comovement between domestic and international prices is stronger when international prices are low than when they are high (for example, in the case of rice and wheat shown in panels 2 and 3 in Figure 3.6). This may suggest that the government is more unwilling to allow the pass-through when prices are higher (see Misra and Misra 2009).⁸

Which Commodities Drive Food Inflation?

Two main factors determine the contribution of different commodities to food inflation: the weight of each commodity in the overall food basket, and the change in prices of these commodities. To begin with, we look at broad trends in inflation of primary and manufactured food items. From Figure 3.3 we know that primary food items constitute a bigger weight in the Indian food basket. At the same time, the inflation rate for primary food items is typically also higher than for manufactured items (Figure 3.7). For example, in 2010 the difference was as high as 10 percentage points. Moreover, the long-term trend in inflation for primary products is always above that for manufactured food items. Hence, given both high weights and high inflation rates, we can expect primary commodities to be contributing to a larger extent to overall food inflation (Figure 3.8).

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Food Price Inflation Rate: Primary and Manufactured Products

(Percent)

Sources: Ministry of Commerce and Industry; and authors’ calculations.Note: This figure shows the average year-over-year inflation rates based on the wholesale price index. The trends are based on a Hodrick-Precott filter with a smoothing parameter of 100.

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Food Price Inflation Rate: CPI and WPI

Source: Ministry of Commerce and Industry.Note: This figure shows the average year-over-year food inflation rates. CPI = consumer price index; WPI = wholesale price index. The WPI figure for 2011 is based on January–May; for the CPI, from January–April. CPI-IW, CPI-AL, CPI-RL, and CPI-UNME are the CPI for industrial, agriculture, rural, and urban non-manual employees, respectively.

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To dig deeper into the specific commodities that contributed to food inflation, we look at all 112 commodities in the 2004–05 food basket and use a simple methodology to quantify their contributions. Recall in equation 3.1, we defined the food price index using a Laspeyres formula. Taking first differences of equation 3.1, and dividing by $I_{t-1}^F$, we get:

Or,

where $W_i^F$ is the weight for i in the food basket in the base period. ${\text{π}}_t^F$ denotes the aggregate food inflation rate and ${\text{π}}_{it}^F$ denotes the inflation rate for commodity i at time t. Hence, the contribution of item i in explaining food inflation is given by:

${\text{C}}_{it}^F$ is a product of three factors: the share of commodity i in the food basket, the inflation rate of i, and the ratio of the price index of i to the overall food price index in the previous period. Hence, commodities with higher weights and high inflation are the natural candidates for being among the biggest contributors to overall food inflation. However, commodities with very high weights in the food basket could also contribute significantly, even though the rise in their prices is not very significant. The converse could be true as well—there could be commodities with relatively low weights that experience a sharp increase in prices, and could contribute to overall food inflation.

Based on this logic, we classify all the commodities in the food basket into four bins: (1) high inflation and high weight, (2) high inflation and low weight, (3) low inflation and high weight, and (4) low inflation and low weight. High and low are defined as above and below the median of inflation and weight, respectively. The commodities falling in the high-inflation, high-weight bin are the most likely candidates for the biggest contributors to food inflation. Although the list of commodities varies, the high-inflation, high-weight commodities can be broadly classified into four groups: animal source food; fruits and vegetables; staples such as rice and wheat; and processed food, including sugar and edible oils.

In what follows, from equation 3.3, we compute C_if for each of the 112 commodities in the food basket. We first take the annual averages of the individual commodity indices as well as of the overall food index, and then calculate the respective inflation rates. We use the weights in the 2004–05 basket for the calculations. Finally, as a check, we make sure that the following identity holds in the data:

The top 50 contributors and their contributions for some selected years—1998, 2008–2013—are shown in Annex 3.1, and the top five contributors in each of these years are shown in Figure 3.9. The contributors to food inflation are typically concentrated in a few commodities, with the contribution of the top five to overall food inflation typically close to half (reaching 56 percent in 2012). The top contributors are commodities in the high-inflation, high-weight bin: these include milk and fish in the category of animal source food; onions, potatoes, cauliflower, and mangoes in fruits and vegetables; sugar and edible oils (mustard, rapeseed oil, vanaspati [hydrogenated vegetable cooking oil]) in processed food; and rice and wheat in cereals.

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Contribution of Leading Commodities to Food Inflation

(Percent)

Sources: Ministry of Commerce and Industry; Government of India; and authors’ calculations.

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Some variation in the top group has also occurred. While fruits and vegetables were the biggest contributor in 1998, and both animal source foods and processed foods were equally important in 2009, animal source foods have been the leading candidate since 2010. The leading individual items contributing to food inflation have also varied—milk in 2010–12, sugar in 2009, rice in 2008, and mangoes in 1998. Cereals, especially rice, re-emerged as the leading contributor to food inflation in 2013.⁹ On the other side, milk has been important over the entire period, and its significance has increased, with its contribution increasing three times by 2010.

What Factors Explain the Rise in Food Inflation? Case Studies of Commodities

Here, we examine in detail the factors that could explain the inflation patterns for commodities, which we have already identified as primary contributors to food inflation during the past two decades. These factors can be classified into long-term factors and those that are more important in the shorter term. The long-term factors include both structural factors and government policies. In particular, we consider the following:

• Demand-side factors such as those related to the changing structure of demand away from cereals toward high-value items such as livestock products. This can be attributed to rising incomes and changing lifestyles, such as from urbanization.

• Supply-side factors such as changes in production and productivity. On the supply side, the performance of the agricultural sector in India has been subpar. The sector managed an average annual growth rate of merely 3 percent, and with high volatility, in the 20 years since 1990. In particular, India now has lower yields per hectare of cereals than most comparable countries, including Bangladesh, China, Pakistan, and Sri Lanka.¹⁰

• Long-term policies such as the cereal-centric focus of the government through a system of producer support prices and maintenance of grain reserves. These long-term structural factors contribute toward built-in inherent inflationary pressures, making the system vulnerable to price increases from short-term shocks.

In addition to longer-term structural factors and policies, short-term factors also contribute to inflation. These include (1) short-term shocks, such as negative shocks from natural disasters like droughts and floods, and positive income shocks, such as rural employment guarantee schemes; (2) domestic policy interventions such as revisions to minimum support prices; (3) trade policy responses such as easing export restrictions; and (4) movements in international commodity prices.

We identified four groups as leading contributors to food inflation: animal source food, fruits and vegetables, processed food, and cereals. We now analyze the trends in inflation for selected items under these groups that we identified as important.

Animal Source Food: Milk

Milk was the most important contributor to food inflation from 2010 to 2012, and has consistently been among the top three contributors since 2008. Moreover, its contribution has followed an upward trend, increasing almost three times from 1998 to 2010. Figure 3.10 shows the evolution of the inflation rate and production of milk over time. Two stylized facts emerge from this figure: the inflation rate for milk has been rising since 2005, with particularly sharp increases in 2009 and 2010; and it appears to have moderated since 2011. In addition, there were price spikes during the lean season relative to the flush season (Figure 3.10, panel 2). We classify the factors responsible for explaining the inflationary patterns in milk as long term and short term.

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Behavior of Milk Prices and Their Key Determinants

Sources: FAOSTAT database; Government of India; Ministry of Commerce and Industry; and authors’ calculations.Note: The dotted line in the first panel shows the Hodrick-Prescott filtered trend.

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Long-Term Factors

Milk production globally has undergone a sustained increase, with India now the world’s biggest milk producer. The country’s production more than doubled from 1990 to 2012 (Figure 3.10, panel 3), and accounts for about 17 percent of the world’s total milk production (Kumar and Staal 2010). Moreover, India’s per capita availability of milk increased from 176 grams per day in 1990 to 290 grams per day in 2012 (Economic Survey Statistics 2012–13). This is comparable with the world per capita availability of 289 grams per day for 2011 (Mani 2013). Even so, estimates show that India’s milk productivity is quite low. Annual milk yield per dairy animal in 2003 was about one-tenth of that achieved in the United States and about one-fifth of New Zealand’s (Hemme, Garcia, and Saha 2003).

Indian dairy policies have always protected dairy farmers grouped in cooperatives from low-priced dairy imports (Rakotoarisoa and Gulati 2006). These policies included both domestic support and high trade protection measures. Domestic support has been in the form of subsidies under the government’s Operation Flood program launched in 1970, which were part of the plan expenditure.¹¹ The program is important not only for increasing overall milk supply, but also for smoothing price differentials across time and space, as the program aims to create a national milk grid.

Long-term government trade policy in milk and milk products has also played a role in sustaining inflationary pressures. Trade protection before 1990 mainly took the form of quotas and canalization, whereby all imports were controlled by the National Dairy Development Board. However, the importation of milk powder, under the earlier General Agreement on Tariffs and Trade, was allowed at a rate of zero percent and there was a surge in imports of milk powder. The zero-duty bound rate was subsequently renegotiated and tariff rate quotas imposed since 2000.

India currently allows imports of milk and milk products using a system of tariff rate quotas and import permits. Nonfat dry milk imports, subject to quotas of up to 10,000 metric tons, attract a 60 percent basic duty; and above-quota butter oil imports at a 30 percent basic duty. The tariff rate for imports below 10,000 metric tons is 15 percent. For dairy, India allows exports only of nonfat dry milk.

Domestic policy long subjected the dairy industry to licensing. This was progressively “de-canalized” after 1991 when the private sector, including multinational companies with milk processing and manufacturing plants, were allowed entry.¹² These supply-side measures increased milk production, yet estimates suggest that in 2004 only 20 percent of milk was distributed through coordinated channels despite these organizational changes. Since 2000, the share of distribution through the organized sector has increased, but only marginally. Of total marketed milk, 75 percent is still handled by informal or traditional milk marketing chains (Kumar and Staal 2010). As a result, even though production increased, the dominance of the informal sector in milk marketing precludes smoothing of supply over time and across space—and this could partly explain the sustained inflationary pressures in milk. The government has approved three new programs to increase productivity and strengthen milk marketing chains; namely, the National Dairy Plan in 2012, the Intensive Dairy Development Programme in 2013, and the Dairy Entrepreneurship Development Programme in 2013. If implemented effectively, these programs could help mitigate milk inflation.

High inflation in milk can also be attributed to a substantial increase in demand. Based on data from different rounds of the National Sample Survey, demand for livestock products has risen significantly (Gandhi and Zhou 2010),¹³ with the expenditure share of livestock products increasing 21 percent in 2004/05. Furthermore, within this category, milk and milk products have the largest share, at nearly three-quarters, in both rural and urban areas.

The demand for milk and milk products is most sensitive to changes in income. Based on estimates of expenditure elasticity, demand for milk is projected to grow at about 10.6 percent per year from 2004/05, much larger than the rate of growth in its production, of about 4.2 percent between 2005 and 2010 (Figure 3.10, panel 2).

Overall, inflationary pressures in milk can thus be attributed to rising demand, which has outpaced increases in production, and, importantly, to the skewed structure of dairy supply chains in favor of the informal sector and the resulting inability to smooth the supply of milk over time and across regions.

Short-Term Factors

In addition to longer-term structural factors and policies, we identify key short-term shocks, positive and negative, which could have contributed to the observed patterns of inflation in milk. Two developments since 2005/06 that constitute positive household income shocks are worth mentioning: the National Rural Employment Guarantee Scheme was introduced, with the first phase starting in early 2006; and the Sixth Central Pay Commission was implemented, starting in early 2009. Both brought significant increases in the disposable incomes of households. Combined with the high income elasticity of milk, these developments could help explain the rising trend in its inflation since 2005, and the spikes in 2009 and 2010. Furthermore, the droughts in 2009 in north India, which raised the price of fodder and the cost of milk production, could also have reinforced the inflationary pressures from the input side.

The moderation in the milk inflation rate since 2011 could be owing to three main factors. First, the improved supply of fodder reduced the costs of milk production and eased inflationary pressures. Second, the slowdown in the economy may have checked the rising demand for milk and milk products. Third, recent government trade policy responses may have played a role. The government allowed duty-free imports of 30,000 metric tons of skimmed milk powder and 15,000 metric tons of butter oil in February 2011, which may have eased supply pressures. At the same time, it imposed an export ban on milk powder and casein, which was lifted in June 2012. Since both exports and imports of milk and milk products constitute a very small share of production (less than 1 percent), these trade measures could, at most, have played only a marginal role in easing inflationary pressures in milk. And since the drop in the inflation rate to single digits is fairly recent, it remains to be seen how far these measures will remain successful in taming inflation.

Cereals: Wheat and Rice

Cereals have generally been among the top 10 contributors to overall food inflation. In some years, rice in particular has been the top contributor, as in 2008 and 2013. Cereals are important to study for three main reasons. First, the government intervenes extensively in the cereals markets, along the supply chain in pricing, procurement, stocking, transport, and distribution. The government is also more proactive in fending off inflationary pressures on cereals than it is with other commodities. Second, cereal prices can put pressure on prices of other food items; for example, through substitution in production away from noncereals. And third, rural wages are linked to cereal prices; hence a rise in these prices could raise production costs for other food items and for nonfood products.

Figure 3.11, panel 1 shows the evolution of the inflation rate for rice and wheat, and its potential correlates. The following four facts emerge from the data: (1) inflation peaked in 1999 for both wheat and rice: in 2006, 2008, and 2012 for wheat, and in 2008 and 2013 for rice; (2) during the peak of the global food price crisis, Indian cereal prices remained comparatively low; (3) the correlation of domestic prices of rice and wheat with international prices is weak; and (4) inflation rates for both wheat and rice picked up from 2011 after declining since 2009.

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Behavior of Cereal Prices

Source: Ministry of Commerce and Industry.

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Long-Term Factors

The production of cereals, wheat in particular, has increased (Figure 3.11, panel 1). Between 1990 and 2012, rice production grew an average 1.8 percent and wheat 3.2 percent annually. However, the adoption of technology in cereal production and better seed varieties by farms has been slow.

Overall, the significant increases in productivity achieved during the Green Revolution have stagnated. Average annual growth in production in the 1990s and 2000s increased only marginally for rice, and declined for wheat. This has been attributed to, among other causes, excess use of fertilizers (particularly urea, which is heavily subsidized) and to falling groundwater levels caused by suboptimal crop choices.

Until about 2009 coarse cereals performed much better than wheat and rice, with an increase in yields of nearly 4 percent in the past decade. Other lagging crops, such as oilseeds and pulses, also outperformed cereals in yields (pulses only marginally). In fact, yield growth across all principal crops is exceeded by cotton, where yields grew as much as 11 percent in the past decade (attributed to the spread of Bacillus thuringiensis cotton). Among the major crops that performed worse than the main cereals are sugarcane and some pulses in the disaggregated category.

However, recent years have been exceptional for cereals production in India, particularly for wheat. Wheat production increased 7.5 percent in 2011 and 9.2 percent in 2012, due to higher planting following the government’s policy encouraging a steady increase in minimum support prices and generally favorable weather conditions.

On the domestic policy side, the government has intervened heavily in the cereals markets through three main policies: procurement, stocking, and releases through the public distribution system.

The procurement system, in the form of minimum support prices, aims to ensure a reasonable income for farmers and adequate availability of food grains to consumers at reasonable prices. As such, it plays an important role in determining food inflation. The minimum support price acts as a floor and serves as a benchmark for inflation. For it to be effective, the support price has to rise above the market clearing price or the government will not find sellers. Hence, any increases can create inflationary pressures. Gaiha and Kulkarni (2005) showed a strong positive correlation between the minimum support price for rice and wheat and the WPI and CPI-AL after controlling for time trends and levels of income. Although the minimum support price is aimed at providing incentives to farmers, it has often been below international prices. The implication here is that it could act as an implicit tax on farmers, given regulations on exports. Furthermore, as the fiscal costs of the procurement system have spiraled, it has had the long-term effect of reducing public investment in agriculture (Gaiha and Kulkarni 2005).

The government maintains both buffer stocks and strategic grain reserves (the latter since 2008), and uses stockpiling and the release of reserves as tools for price stabilization. On the disbursement side, by keeping issue prices to the public distribution system more or less fixed, the government has tried to stabilize prices for consumers. However, the public distribution system is plagued with leaks and corruption (Kotwal, Murugkar, and Ramaswami 2011) and is inadequate for shielding consumers from price pressures.

Because of a steady increase in the minimum support price and record production, government food grain (wheat and rice) procurement increased strongly from 2007 to 2012. However, government wheat procurement in 2013/14 fell 34 percent because of high open market prices and speculation that domestic production was lower than officially claimed (Singh 2014).¹⁴

On the trade side, exports of both wheat and non-basmati rice were banned until the mid-1990s (the ban on rice exports was lifted in 1994 and on wheat in 1995). Starting in 2006, there was again a ban on exports of wheat. Meanwhile, the import tariffs on rice (70 percent) and wheat (50 percent) are prohibitive.

With significant public intervention, the government made small reforms to food policies in the 1990s. It more or less removed restrictions on the interstate movement of commodities and proposed to do away with the Essential Commodities Act and replace it with an emergency act.¹⁵ Because agriculture is a state matter, the government has advised states to amend laws such as the Agriculture Produce Marketing Committee Act. In reality, however, most of the restrictive policies have remained unchanged (see Jha, Srinivasan, and Ganesh-Kumar 2010).

Short-Term Factors

Weather is a primary short-term factor contributing to inflation in cereals. A drought in 2009 in north India, for example, was a negative shock, mainly affecting rice production, which fell 8.3 percent in that year (Figure 3.11, panel 1). However, the weather for wheat production in the four years after 2009 has been favorable.

Although the support-price system is a long-term factor in inflation, as already discussed, we now consider revisions in the minimum support price as a short-term cause of inflation. In principle the minimum support price is based on the cost of cultivation calculated by the Commission for Agricultural Costs and Prices, which accounts for all expenses in cash and in kind, rent paid for leased land, the imputed value of family labor, and interest costs on working and fixed capital. Since 1997–98 minimum support prices have often been set higher than the cost-of-cultivation benchmark (for political reasons). In 2001–02, for example, the weighted average cost of cultivation of eight wheat-producing states was Rs 4.83 per kilogram, while the minimum support price was set at Rs 6.20 per kilogram (Gaiha and Kulkarni 2005).

The minimum support price generally gets revised upward every year, but the magnitude of the increase can vary, sometimes substantially. For example, the minimum support price for both wheat and rice increased one-third in both 2008 and 2009. The increases, moreover, have tended to be higher in high-inflation years to maintain procurement levels. For wheat, the sharp increases in the minimum support price by 15 percent in 2006–07 and 33 percent in 2007–08 coincided with the steady rise in the inflation rate throughout 2006 and the first half of 2008 (Figure 3.11, panel 1). Ideally, the minimum support price should be low so as to reduce procurement in high-inflation years and high in low-inflation years to increase procurement and stock up, as argued by Basu (2010). The absence of any downward revision in the minimum support price, and the lack of adjustment for inflationary pressures, are important factors for inflation in cereals. For example, domestic rice prices have shown a strong upward trend since the beginning of 2012/13 because of significant increases in the minimum support price for paddy rice, coupled with relatively tight domestic supplies (strong government procurement and exports). Domestic prices have weakened since August 2013, perhaps owing to a reduction in export demand (Singh 2014).

Another government domestic policy for tackling price increases is the restriction on futures trading. For example, to reduce incentives for hoarding, the government banned futures trading in rice and wheat in February 2007 (Figure 3.11, panel 2).

Among the main short-term measures to address inflationary pressures in cereals, the government has used trade policy; that is, allowing imports and restricting exports during times of adverse production shocks. The peak in wheat inflation in November 2006 of nearly 30 percent was followed by immediate action with the government importing nearly 6 million tons of wheat, putting significant downward pressure on prices. Concomitant with the May 2008 peak in the inflation rate of nearly 14 percent, the government again imported 1.7 million tons in that month. Export bans were placed on wheat in February 2007, immediately after the inflation rate peaked, and on non-basmati rice in April 2008 during high and rising inflation. Overall, the trade policy response for cereals has been marked by prompt government reaction to rising inflation—in stark contrast to the trade policy response to other commodities, particularly sugar and milk.

With bumper production, the most recent trend in trade in cereals has been more on the export side. Wheat exports took off in August 2012 (the 2007 wheat export ban was lifted in 2011) after the government announced exports of wheat from its own stocks. However, weak international prices affected government wheat exports during 2013/14, forcing it to lower the minimum export price from $300 per ton to $260 per ton in November 2013. Overall, India’s wheat exports have not been price competitive in international markets in recent years.

For rice, the government lifted the export ban on non-basmati rice in September 2011, which had been in effect since April 2008. India has since become the world’s leading exporter of rice. Export figures for 2013 indicate total rice exports of 10.5 million tons in that year. Exports of basmati rice continue without quantitative restrictions subject to a minimum export price, which changes from time to time. In July 2012 the government removed the minimum export price requirement on basmati rice; the import duties on rice were lifted in March 2008, although there have been no rice imports since then (Singh 2014). The increase in exports of cereals since 2012 is a consequence of increased production and excessive stocks. But this cannot by itself be considered a cause of inflation, which can be predominantly explained by domestic interventions such as the system of support prices.

Conclusions and Policy Implications

This chapter uses a disaggregated commodity level and a high frequency dataset to provide a forensic account of food inflation in India over the past two decades. Our analysis comprises several elements. First, we show that the long-term trend for food inflation has followed a U-shaped path over this period, with a clear reversal of a declining trend starting in the early 2000s. Second, there is evidence for only a moderate correlation between international and domestic food prices, albeit with significant variation across commodities, based on tradability. For example, edible oils exhibit a higher degree of pass-through from international prices. Moreover, the correlation tends to be lower when world prices are high than when they are low.

Rather than treating food as a monolith, we disaggregate it into its different components. We explicitly quantify the contribution of specific commodities to food inflation. Although there is some variation over time, the top contributors are typically milk, fish, sugar, rice, wheat, onions, potatoes, and, to a lesser extent, edible oils.

Finally, we conduct case studies of specific items from the list of top contributors to study the inflation patterns and the factors explaining them. The chapter focuses on milk for animal source foods, and wheat and rice for cereals. The experiences of each of these commodities tell a distinct story about the factors that could be explaining inflation patterns and policy responses. For milk, persistent demand-supply gaps owing to changing consumer tastes, coupled with the nature of the milk supply chain (which prevents smoothing of milk supply over time and across space), could play an important role in explaining persistent milk inflation. For cereals, inflation is more likely a story of excessive domestic interventions, including procurement, stocking, and distribution.

Some unifying messages emerge from the case studies. We find that long-term structural factors and lasting government policies, as well as short-term exogenous shocks and temporary government responses, could explain the patterns of inflation across commodities. Given the built-in inflationary pressures resulting from the existence of long-term factors, short-term shocks can accentuate the effect on inflation. The intensity and speed of government responses also determines how quickly and to what extent inflationary pressures are reined in. Moreover, commodity-specific policies have both direct effects on the targeted sectors and possible spillovers to other sectors. For example, the cereal-centric policies of the government have effects on the supply of high-value items like fruits and vegetables.

The findings in this chapter have several policy implications. A case can be made that in the context of a developing economy like India, both the central bank and other branches of the government can play a meaningful role in tackling inflation. Important policy lessons also emerge for various government departments from the commodity-level analysis. Trade barriers are typically very high and often prohibitive for most food items, including for the top drivers of food inflation. Yet, in the case of the commodities we studied, trade policy (such as export bans, duty-free imports, and so on) has been used as a shock absorber to cool inflationary pressures. One exception (not discussed in this chapter) is edible oil, which was liberalized in the mid-1990s and where inflation has been quite muted. A similar story emerges for pulses, where increased imports moderated inflation. Both raise the question of whether the patterns of inflation we observe in most commodities would have been different were trade more liberalized to begin with.

The case studies further suggest that the effectiveness of trade policy as a stopgap tool to curb inflation depends on the timing of the response. For example, political expediency resulted in a rapid response to inflation in onions and cereals. But the response for milk and sugar was much delayed. Promptness in the implementation of trade policy measures is crucial for two reasons. First, it takes time to build new trade relationships if none existed before (as noted earlier, for clearance to import livestock products, 30-day advance notice is required). Second, international prices, particularly for large buyers like India, could change, affecting import prices.

Based on the case studies, one clear policy message to emphasize is that curbing inflationary pressures could be a rationale in itself to reduce long-lasting import barriers—both tariff and nontariff—in agriculture.¹⁶ Temporary and targeted export regulations could still be warranted from the perspective of controlling inflation, although the long-term application of export regulations needs to be avoided, because it could generate perverse incentives against raising production and productivity.

This chapter’s overarching message is that the multiplicity of instruments (different forms of support prices, domestic subsidies, and futures trading, to name a few), as well as the number of government agencies involved, makes the task of controlling inflation a daunting challenge. The in-depth case studies suggest that, in general, policies and institutions primarily created for increasing availability and stabilizing prices—such as relatively closed borders and domestic restrictions—could have actually aggravated the food inflation problem. Therefore, India’s persistent food inflation should perhaps reopen the debate over whether a more open and less interventionist stance by the government can stabilize food prices and, hence, overall inflation. The complex web of multiple agencies and multiple instruments, potentially working at cross-purposes, can make the task of enhancing the effectiveness of monetary policy an uphill one.