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India: Selected Issues Paper

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
March 2015
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India’s Food Inflation: Causes and Consequences1

Food inflation has often been singled out as a key driver of India’s high and persistent inflation. India’s food inflation developments over the past decade appear to have reflected demand pressures (driven by strong private consumption growth), which have often outpaced supply of key food commodities. Therefore, despite recent moderation, India’s food inflation pressures are likely to re-emerge as economic growth picks up. Supply side measures that will contain food inflation pressures on a durable basis remain critical to provide a robust foundation for adopting a low-inflation objective.

1. Inflation is a key macroeconomic challenge facing India. Elevated inflation coinciding with the recent growth slowdown has distinguished India from other major emerging market economies. A number of factors have caused high Indian inflation: food inflation feeding quickly into wages and core inflation; entrenched inflation expectations; cost-push shocks from binding sector-specific supply constraints (particularly in agriculture, energy and transportation); and pass-through from rupee depreciation.

India: Headline and Food Inflation

(y/y percent change)

Sources: Haver Analytics; and IMF staff calculations.

2. Food inflation has often been singled out as a key driver of India’s high and persistent inflation. High food inflation and its prominence in shaping wage setting and in forming inflation expectations are key features of Indian inflation. Food inflation, therefore, has had a non-trivial impact on aggregate retail inflation (headline consumer price inflation) in India, presenting a challenge for monetary policy management. The importance of food inflation in shaping inflation dynamics in India is due to the following factors (see also Anand and others, 2014):

  • High share of food expenditure in total household expenditure and the correspondingly high weight of food in the consumer price index (CPI) basket (47.6 percent);
  • Inflation expectations are largely anchored by food inflation; and
  • Wage indexation to consumer price inflation and thereby indirectly to food inflation.

India: Food Inflation and Inflation Expectations

(In percent)

Sources: Reserve Bank of India; and IMF staff calculations.

3. Food inflation has exceeded non-food inflation by about 3½ percentage points on average during 2006/07–2013/14, thus contributing directly about 1¾ percentage points on average to headline CPI inflation. Furthermore, through its second-round effects on core inflation, food inflation added to inflationary pressures. Growth in food inflation outpaced non-food inflation by almost 30 percentage points during 2006–10, exceeding non-food inflation by an average of almost 7½ percentage points per year during this period. However, since 2010, relative food prices staged a relatively moderate gain. In turn, non-food inflation picked up, averaging 9½ percent during 2010–13, a full 3 percentage points higher than the average of 6½ percent recorded during 2006–09. Thus, even as relative food prices rose only moderately during 2010–14, headline inflation remained high, with emerging entrenched inflation expectations, and firming of the food-nonfood inflation spiral (with food inflation feeding quickly into wages and core inflation).

India: Food vs. Non-food Inflation

(Index, 2006 = 100)

Sources: Haver Analytics; and IMF staff calculations.

4. Domestic food demand and supply factors underpin India’s food price dynamics. As India’s food imports account for only about 1 percent of GDP, a large part of which is edible oil, relative food prices (food versus non-food prices) play a key role in equilibrating India’s food demand and domestic supply. Acceleration of India’s economic growth during 2003–11 to an average of about 8¼ percent (up from an average of just below 6 percent recorded during the preceding decade) was accompanied by an even stronger pickup in the growth of private consumption. At the same time, average agricultural GDP growth remained essentially unchanged at about 3¼ percent per year, resulting in excess demand for food, giving rise to relative food-price inflation.

India: Relative Food Inflation: Predicted vs. Actual

(In percent)

Source: Anand and Tulin (2015, forthcoming).

Note: Predicted relative food inflation is calculated as a solution of a general equilibrium system with demand specified using an estimated two-stage Quadratic Almost Ideal Demand System for India and historic supply growth rate for six major food expenditure categories, overall private consumption and non-food inflation.

India: Private Consumption Growth

(Annual percent change)

Sources: Haver Analytics; and IMF staff calculations.

India: Supply and Demand for Food

(Annual percent change, real)

Sources: Haver Analytics; and IMF staff calculations.

5. As Indian economic growth picks up, food demand pressures are likely to re-emerge. Analysis of Indian household demand patterns using a system of estimated demand equations suggests that relative food price pressures are likely to re-emerge as economic growth picks up. An estimated sample average household food budget expenditure elasticity of 0.64 implies that if food supply growth rates stay near their 10-year historic averages, then relative food price pressures will likely reappear when annual private consumption growth exceeds five percent.2

India: Fitted Engel Curve for Food

6. Recent steps to contain food inflation will help in the short run, until durable measures to increase food supply are in place. During the fiscal year 2014/15, the Government of India took several steps to rein in food inflation. Specifically, the rise of minimum support prices for key agricultural commodities, wheat and rice in particular, were set at low single digits. Additionally, the release of food grains from the Central Pool into the market, and adjustment of the buffers norms of these foodgrains to levels significantly below prevailing actual stocks, were announced. These measures have helped lower cereal (rice and wheat) inflation. Nonetheless, going forward, as excess demand will likely re-emerge, a durable increase in supply would be required to keep food inflation in check.

Rice: Prices and Central Pool Stocks

Sources: CEIC; Haver Analytics; Food Corporation of India; and IMF staff calculations.

Wheat: Prices and Central Pool Stocks

Sources: CEIC; Haver Analytics; Food Corporation of India; and IMF staff calculations.

7. Demand pressures will remain strong for high-value foods, such as dairy products and animal-based proteins. With rising incomes, food consumption typically shifts away from simple starchy plant-dominate diets towards more nutritious and high-value foods that include a range of dairy products, vegetables and fruits, and especially meat. Food expenditure elasticity estimates for animal-based proteins as well as dairy products suggest that growth of demand for such products will remain about 1.5–1.7 times the demand growth for cereals and pulses.

Food Expenditure Elasticities: Relative to Total Household Expenditure(weighted by sample actual household expenditures)
Relative to pulses
Egg, fish and meat0.591.52
Milk and milk products0.651.65
Cereals and products0.470.59
Pulses and products0.391.00
Vegetables and fruits0.481.23
Other (oils and fats, sugar, condiments and spices)0.461.18
Source: IMF staff estimates.
Source: IMF staff estimates.

8. High-expenditure-elasticity food products have also experienced relatively higher supply growth rates, which if sustained would help contain food inflation. Estimates of domestic supply growth over the past decade suggest that products facing relatively higher demand growth have also seen relatively higher supply growth. For example, the growth rate of domestic supply of cereals has been about half of that of animal-based proteins. Therefore, if relatively higher supply growth can be sustained going forward, this will help contain relative food-price pressures associated with income growth.

Average Growth in Domestic Supply(in percent per year)
2005/06 - 2012/13
Egg, fish and meat4.8%
Milk and milk products4.6%
Cereals and products2.6%
Pulses and products5.0%
Vegetables and fruits4.8%
Other3.6%
Source: CEIC; and IMF staff estimates.
Source: CEIC; and IMF staff estimates.

9. In the absence of a stronger food supply growth response, relative food inflation can contribute about 1¼ percentage points to headline inflation annually. Indian food inflation is likely to exceed non-food inflation by 2½–3 percentage points per year, assuming private consumption growth picks up to 7 percent per year and food supply growing at historic rates. Therefore, the suitability of a long-term inflation target of 4 percent—as recommended by Patel Committee Report—depends on enhancing food supply, agricultural market-based pricing, and reducing price distortions. As well, our simulation analysis indicates that in light of India’s supply-side vulnerabilities, the recommended band around the inflation target of +/− 2 percent is broadly appropriate. Finally, at the current juncture where relative food prices do not appear to be a key driver of headline inflation, ensuring a durable reduction in headline inflation requires a continued tight monetary stance to lower core inflation, and to reduce inflation expectations and to anchor them at a lower level.

Appendix. India: Fitted Engel Curves for Key Food Expenditure Categories
References

    AnandR.D.Ding and V.Tulin2014Food Inflation in India: The Role for Monetary PolicyIMF Working Paper 14/178 (Washington: International Monetary Fund).

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    AnandR. and V.Tulin2015Understanding India’s Food Inflation: Demand and Supply and the Way Forwardforthcoming IMF Working Paper.

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    SonnaT.H.JoshiA.Sebastian and U.Sharma2014Analytics of Food Inflation in IndiaReserve Bank of India Working PaperOctober2014Reserve Bank of India.

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    Ganesh-KumarA.R.MehtaH.PullabhotlaS. K.PrasadK.Ganguly and A.Gulati2012Demand and Supply of Cereals in IndiaIFPRI Discussion Paper 01158January2012.

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1

Prepared by Volodymyr Tulin.

2

The analysis is based on data on household food expenditure and consumption patterns taken from the India’s household survey database (NSSO 68th round for 2011/12).

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