On why inflation is low for June 2014 despite bad monsoons

Hiya Folks! Read in the Economic Times today (15/7/14) that happily, for the Modi Sarkar, the effect of the rainfall has not yet petered down into the prices of food and other commodities. WPI inflation, the article claims, is at a 4-month low of 5.43% and down from 6.01% in May. However, ET also suggests, rather ominously, that its a matter of time before it does enter the indices and hence it looks like a rate reduction in the 7th August credit policy announcement is unlikely. I agree. Inflation indices that seem benign today are the result of the RBI being consistently tough in keeping the rates high; a small slip, and we could well move into much more uncomfortable inflation figures, that would hurt the Aam Admi pretty badly.

But how long will it be before the indices start showing the effect of an exceptionally dry June? I thought that a quick look at the data would clear up matters significantly. The first place I went to was the Indian Meterorological Department website, where to my trauma, I found excellently maintained data sources on rainfall every month, every year, as per district, region, state….you name it and they have it. Trauma? You may well ask, but given my earlier brushes with badly maintained data sets at various Government levels, it has become something of a favourite past time to bash up Government departments for not maintaining proper data. So when my favourite punch bag suddenly became a Santa goodies bag, I was flummoxed and flustered, to say the least. But bravely, I surfed on and got my hands on data for average Indian rainfall for the past 10 years. Now, in what follows I give a very basic analysis of how I am viewing things. If one just takes the growth rate on rainfall over the last year and compares it to the y-o-y GDP growth rate, this is what one would get:

Rainfall and GDP

The X-axis is moving from 2001 to 2013. Now, while it is a MUCH better idea to look at rain deviations from the long term period average, I have done a level 1 analysis here and am just looking at y-o-y trends for a rough picture. You can immediately see that the rainfall performs very poorly in 2009, which indeed has been identified to be a pretty bad drought year for India in the recent past.

Now, its interesting to note that the GDP growth rate moves from around 8% in 2009 to 10% in 2010, despite the drought conditions. How, I ask myself, does this become possible? One of the answers obviously is that the agriculture sector contributes to less than a quarter of Indian GDP and so, any effect of the monsoons, on the growth rate could be pretty damp. So, while the agricultural GDP may have fallen, India still shows better growth on the basis of a service sector responding to a strong global recovery. This also perhaps points to the fact, that the bad monsoon spell in 2014 so far, may not have an immediate impact in terms of slowing down the GDP growth rate.

However, even though the effect of the monsoon on the GDP growth rates may have been damp in the 2009 episode, I believe that this effect will definitely show itself in terms of higher food prices and in terms of higher inflation in 2009 and 2010. I go back to the inflation statistics to confirm this. In what follows is an analysis of WPI because WPI being at a 4-month low was the trigger point for my thoughts today.

Interestingly, the WPI inflation for the year 2009 itself stands out in the crowd because it is so phenomenally low! Take a look at this:

WPI trends post 2009 drought

Of course, while the WPI is low, it undoubtedly shows a hike (pl note that WPI inflation figures are to be read as y-o-y) all through the rains and from October onwards moves into an alarmingly high slope category. I also see, albeit just on visual inspection, that the inflation effect persists throughout the next two years: The top moving inflation series are in 2010 and 2011. The persistence makes sense. A bad monsoon means that the ensuing kharif and the rabi seasons would underperform, supply would get affected and the prices would rise. In a traders’ market with alarmingly low levels of legal compliance on hoarding, there would be immediate incentive to hoard the non-perishables and the not-so-perishable cereals/ pulses/ vegetables, thereby driving up the prices. In the meanwhile, food inflation would also contribute highly to the retail inflation, which in turn would get reflected in the dearness allowances, thereby sparking off a wage-price spiral. The Government would be tempted to raise the wages paid under schemes such as NREGA, to make sure that the rural labourers, the beneficiaries of the scheme, always have enough money to purchase sufficient amount of food. This would drive up the farm sector wages, further increasing agricultural costs and further putting pressure on the already high food prices. These factors have been well-documented and are a part of the agriculture-food-inflation economics that is India.

Visiting these facts today is important because it helps us to sense where the rogue fundamentals affect the system. I have a feeling that this bad monsoon may not immediately take off on bad growth figures, but it will play sharply on inflation. So reduction in the rates in the August policy would be premature and indeed, dangerous. Whilst the monetary policy holds on to tighter reins, the Modi Sarkar would really need to crack the whip on hoarding. Unless we get some action in that sphere, there is no way of avoiding high food inflation in the future. The other thing the Government needs to do is control the urge to increase MSPs/ NREGA wages in anticipation of higher food prices. It is very difficult to understand whether high NREGA wages are the cause or effect of food inflation. There seems to be some level of bilateral causality between the 2 variables, and I would like NOT to see any immediate action in that sphere.

That’s about it from my end. Food is going to get expensive, folks…food for thought, anyone?

*A disclaimer before I end. These are quick reactions to the piece in ET this morning, not well-crunched research results.

**I also want to thank my student Shrabana Mukherjee from Symbiosis School of Economics, who helped me to put together WPI data quickly for this piece.





8 thoughts on “On why inflation is low for June 2014 despite bad monsoons

  1. Thank you for the food for thought!
    It’s evident that bad monsoon is yet another adversity that PM Modi needs to deal with and the public need to wait longer for Achhe din to arrive. Most parts of india are staring at a drought as we are witnessing 43% below normal monsoon. At this stage the two keys things to put in check would be: a) definitely as you mentioned put a stop to hoarding or somehow effectively release the tons of idle grain in govt warehouses.
    B) adopt a fair and Innovative strategy to link mnrega to increase Agricultural output so that the cost burden to the farmer is reduced.
    The problem with not increasing MSP is that often if free market forces are allowed to operate in mandis is that the benefit of higher prices in case of low supply are reaped by the middlemen and not the producer, he’ll get low rates inspire of a supply shock!!!
    Shocking isn’t it


    • Hi Abir!

      Good to see you here…
      Keeping MSPs at the current level means that the farmers get a bad price and raising it means that the consumer gets a very high price. What is to be thought of is: Is the MSP really a food security tool or is it a farmer protection tool. If the prices in the open market are anyway going to be high because of a shortage, is there really a need to increase the MSP just for a political advantage? This year, for the Kharif season, the MSP for paddy has rise from Rs. 1310 per quintal to Rs.1360 per quintal, after which several Shetkari Sanghatanaas in Maharashtra have accused the NDA of being UPA 3! They are saying that such a petty increase in the MSP does not protect them at all..but I feel that the open prices are anyways going to be so much higher…is there a need for further increment in MSP?


  2. Good evening Madam
    What if the government somehow comes out with a direct marketing strategy and dissolve APMC? In such a case increasing MSP or NREGA wages may not effect the inflation too much. And further we may even reduce the problem of hoarding.


    • Hi Akash,
      Dissolving the APMC is the very first action that the Government needs to move on, very quickly. But the politics around the issue is rather sticky and hence, we may not get the desired speed on dissolving these committees.


  3. Good Morning Ma’am,
    Perhaps the revival of specialized financial institutions which look into long term project finance could help. If I am correct RBI has, in fact allowed banks to raise long term bonds to finance infra projects, for which the SLR and other requirements don’t have to be meet.


    • Hi Anvit,
      Yes, the move to do away with CRR and SLR limits on infrastructure means that FIs will feel friendlier about lending money to these projects. But the moot point is, where is the money? The households are so terrifically shy of banks right now, that to coax them into deposits is near impossible till inflation is reigned.

      If you remember, “investments” are by public sector and private sector. Households only consume but we classify their real estate and gold holdings as “investments”…now I also looked at the trends in investments (around 33% of GDP) and I find that public sector investments are steady at 8% of GDP; private sector has reduced sharply in the past 5 years and most “investment” happening in India is by households into “construction” read real estate…this kind of construction gives short term growth and persistent inflation…we need construction of infrastructure…

      The move by RBI to have small banks in rural areas does make sense though…I like that thrust on financial inclusivity..

      Keep reading!


  4. Hi Madam,

    I read this article today. I understand the context in which this article was written. But there have been quite a few developments in the past few months. So I was just curious to know your thoughts on that.

    After June, the monsoon picked up and the the rainfall shortage was not as much as it was expected to be. Do you still think that there will be a rise in the inflation although with a lag?

    The government has also suggested that NREGA should be restructured and which seems to be a step in the right direction. Any thoughts on this?

    Also what do you think Raghuram Rajan will do with the policy rates next month when a rate cut is expected?

    Feels like a virtual classroom where I am asking you questions…. 😛


    • Hi Akshay,
      Well, the rainfall truly did pick up after the piece was written and inflation currently seems to be seriously low! But that spectacular performance on inflation has less to do with food and more to do with the $20 per barrel reduction in oil prices that we seem to be enjoying.

      That has immediately prompted pressure on the RBI to raise the rates. Whether such short term windfalls should be accommodated through a monetary stance is a truly tricky question. While there does seem to be room for rate cut, its also important for us to realize that apart from the oil price reduction, there’s precious little that has changed. I think we need to wait and watch till the OPEC meets up next week to take a call on what level of supply members will undertake in the near future. After that meeting, I think the signals will be clearer.


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