India on Wrong Track to Lower Food Prices

On Tuesday, the Reserve Bank of India increased its interest rates – the reserve repo rate (the rate at which it takes away money from the economy) by 50 basis points to 4.5% and the repo rate (rate at which it lends to commercial banks) by 25 basis points to 5.75%. These moves are the second rate-rises this month and the fourth this year.

The reasoning given for these rises in interest rates is that reducing the money supply will curb the high inflation that has been caused by rising incomes and low yielding crop. Indeed, the greatest, most pressing issue that the government has to deal with is rocketing food prices – the WPI (Wholesale Price Index) rose at a rate of 10.55% in June from a year earlier. However, by raising interest rates, India isn’t addressing the issue. No one takes out loans to buy food; hence, raising the interest rates won’t curb consumption. Even if people were taking loans to feed themselves, due to the inelasticity of food products, demand wouldn’t contract significantly. Clearly, the argument that the rising incomes of the middle and upper classes are fuelling inflation in food prices is baseless.

If this inflation in food prices isn’t demand-pull, then it must be cost-push. Indeed this seems to be the case. In June, the government freed the previously state-controlled (and heavily subsidised) diesel prices – leaving them in the hands of the free market. The result of this withdrawal of subsidy is inevitably going to be price rises (we are already seeing this happen). While the prices of cooking fuels – liquid petroleum and kerosene – will remain state controlled, they too were raised by 11.2% and 33% respectively. The effect of these measures is that costs are going to rise all along the food supply chain – from transportation to actually cooking the food itself. This will make food much less affordable for India’s impoverished masses.

While India’s intention to slash its 5.5% budget deficit is laudable, doing so by cutting fuel subsidies from $20 billion to $11.7 is unwise due to its untimely nature. India shouldn’t worry so much about its deficit – the recovery of the international consumer market in the medium-term ought to bring greater profits to India’s exporters. The resulting increase in tax revenues will go some way to reducing the deficit. At this point the government should turn its focus back on the people. Things were better before with the greater fuel subsidies.