Stubborn food inflation By Mohiuddin Aazim

FOOD inflation recorded a double-digit increase in the last three fiscal years and it also remained consistently higher than the overall Consumer Price Index inflation.

Both trends continue through the fourth consecutive year. And it looks uncertain whether the policymakers would succeed in halting these trends in the next fiscal year.

In the current fiscal year food inflation had bottomed out at 7.5 per cent in October 2009 at a time when overall CPI inflation was also falling rapidly. But it began to bounce back since then and shot up to 14.5 per cent in April 2010.

In its third-quarterly report on the state of the economy, the State Bank of Pakistan has pointed out that the rise in food and energy prices seen since January 2010 is now having a strong second-round effect. Commenting on the fact that food inflation remains higher than the overall CPI inflation, the central bank says, this phenomenon implies that domestic consumers are paying the cost of lower productivity in some areas, imperfect markets and government intervention in commodity prices.

“It has also been observed that domestic prices of most of the food items rise with the surge in their international prices. However, in case of a decline in international prices, the pass-through is largely insignificant”, says the report. Examples of this can be traced in case of almost every food item, notably, wheat, sugar, rice, tea, palm oil etc.

Domestic and global supply shocks, low per-acre yield of local food crops, high input costs including the cost of fertiliser, gas, electricity and bank finances, increasing cost of transportation due to upward movements in fuel oil prices, lack of proper storage facilities, ill-timed government intervention in commodity markets, broken links in supply chain and higher commodity prices in the international market during the recession of 2008-09 all have fuelled food inflation.

Over-spending by government and consequent inflationary borrowings from the central bank, presence of a large parallel economy which helps cash-rich middlemen to manipulate commodity markets, lack of political will to enforce competition laws, ensure a disciplined pass-through of international price movements on domestic price-line and contain hoarding, smuggling and other malpractices—and absence of a proper mechanism to protect consumer from undue price-hikes have also made it difficult to keep food prices at reasonable levels.

Managing food inflation is becoming increasingly difficult. The governments—both the elected ones and those run by military dictators—make tall claims about expanding social safety nets and providing relief to the poorer segments of the society. “But no government gives really pro-agricultural growth policies or check speculative activities in commodity markets to keep food inflation low,” says a senior former SBP official.

Many like him think that food inflation cannot be checked unless a policy is framed to accelerate the rate of increase in per-acre yield of food crops and create a balance between the pressing needs of feeding a fast-growing population and earning foreign exchange through exports.

“Take for example, the case of growth in rice exports in the last fiscal year. It helped the country earn substantial foreign exchange but at the same time speculators skyrocketed domestic rice prices,” pointed out a commodity wholesaler in Jodia Bazar.

Government officials say food inflation has remained higher than headline CPI inflation for the last few years also because of increase in support prices of such major crops as wheat, rice and sugarcane. “Now, you have to choose between the two. Allow a rise in support prices to boost agricultural income and eventually move towards food self-sufficiency but let food inflation rise in the short- run. Or let agricultural income and agricultural output remain static and eventually face higher food inflation in the long run,” says a member of the federal government’s economic advisory council.

But he frankly admits that a lot needs to be done in terms of enforcing fiscal discipline and promoting best business practices to keep both headline and food inflation in check.

“At the same time the central bank’s monetary policies should also aim at bringing in some stability in exchange and interest rates and containing currency in circulation to curb inflationary expectations.”

At the time of food price crises like the ones seen in the recent years in case of wheat and sugar it is the inflationary expectation that complicates the crisis. Curbing inflationary expectations need timely actions. In 2009, the surge in sugar prices was not merely because of low sugarcane production in domestic and international markets. The government’s failure to make timely decision on sugar imports and crackdown on hoarders of sugar stocks were also at the root of the problem. Wheat crisis that the country experienced in 2008 was of the same making.

Domestic sugar prices have moderated due to a decline in international prices since January 2010 on the back of increased production in Brazil and India. “However, going forward, sugar-importing countries are expected to make fresh purchases to replenish domestic stocks. Therefore, international sugar prices are likely to rise again by mid 2010,” warns the SBP in its third quarterly report.

The recent easing of wheat prices is also unlikely to last long primarily due to public procurement policy and possible exports.

The latest round of increase in prices of fresh and packaged milk and beef and mutton has also been triggered primarily because of exports of these items amid higher cost of production of dairy and livestock products due to rising electricity and fuel oil prices. The downward revision in domestic fuel oil prices effective from June 1 is likely to be more than offset by an increase in electricity tariff with retrospective effect from April 1.

The central bank is anticipating fiscal deficit of FY10 to reach 5.6 per cent of GDP against the revised target of 5.1 per cent. This is bound to keep inflationary pressures in FY11 as well. The government had aimed at keeping FY10 headline inflation at 9.5 per cent but the SBP has warned that it could reach as high as 12.5 per cent. Amid this situation and in view of the fact that structural problems in food production and food supply chain management remain in place, it would be too optimistic to hope for an immediate relief in food inflation.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/stubborn-food-inflation-760