Any way you look at it, rising food prices do not augur well for the economy

The powers-that-be seem to have decided that food price inflation is not a worry. For them, that is. From a political point of view, it is easy dismiss inflation as a concern of the urban middle- class. So, it seems perfectly logical to decide that the poor farmer needs to be rewarded for his efforts. With agricultural output hit by the bad monsoons this year, and the farm sector in sore need of investment, it is easy to rationalise that high food prices are the need of the hour.

Support prices for all the major crops are being raised—most recently for rice, dal and wheat. For sugarcane, which is bought by mills (not the government), the Centre has set a new, higher, Fair and Remunerative Price (FRP). Union agriculture minister Sharad Pawar said that “we expect the mills to pay more than FRP” as sugar prices are at a high. The case of wheat, one that I am familiar with, is the most perplexing: stocks held in FCI godowns are at an all-time high after two excellent harvests, but so are prices. And there seems to be no move to raise the amount of grain released into the market. Consistent with the broader line on the subject, government thinking seems to be the poorest—whether urban or rural—will be protected from the ravages of high food prices by our Public Distribution System. Little matter that everyone knows how inefficient and leaky this system is.

The writing on the wall is clear—high food prices are here to stay. Figures released in early November food prices are rising at an annual rate of over 13 per cent. Partly because of this, the RBI has raised its inflation forecast for 2009-10 to 6.5 per cent. These new realities make me pause to consider two matters—one macroeconomic, the other sector-specific. On the first, if inflation is projected at 6.5 per cent, then it seems that the long-term interest rate that the Government of India is paying for its borrowings is a steal. The current yield on paper due in 2019 is roughly 7.25 per cent. So, the real rate of interest a buyer of bonds can expect is only 0.75 per cent. This looks completely unsustainable; another reason to buy gold, which investors have been doing in increasing numbers. But, equally relevant, at some point, investors will feel suckered, and hold out for a higher rate of return. This fact, and the uncontrolled deficit of our governments—both Central and state—will lead to higher interest rates sooner, rather than later.

The second, and pretty obvious outcome of food price inflation is the impact it will have on margins for businesses using agricultural inputs. Food processing firms will be the worst hit, with sugar, wheat and milk prices at all-time highs, and no immediate relief in sight. But, agriculture provides inputs to a wide range of industries—alcohol and the downstream chemical industry use sugarcane; agro-residues help feed the paper industry and also fuel captive power generation plants. Across industries manufacturing margins were boosted last year as the slowdown led to reduced commodity prices across the world and the Union government rolled back excise duties across the board. Eventually, tax concessions will have to go, or else government borrowings will keep ballooning, affecting the economy through the mechanism of higher government borrowings. Whichever way you look at it, inflation cannot be good for our economy. It is unclear whether our senior political leaders genuinely believe that high food prices are, on balance, good. Perhaps they are trying to garner political capital from a situation beyond their control, Either way, I don’t like it.