The title of this piece reflects the three most important policy issues facing the government and policy makers in India. It is a well know fact by now that over the years the major contributor to the overall inflation has been food inflation (Basu 2011a). It has also been shown that much of the food inflation has been contributed by inflation in food products supplying protein (Gokurn 2010). However, much of the food price inflation is related to the way the whole system of food production, procurement and distribution takes place (Basu 2011b). So the argument that RBI should not worry about food inflation seems to be valid one. Economics theory tells us that there is not much a policy ( monetary or fiscal) can achieve in case of supply shocks.  Also, given the fact that RBI also has to manage the exchange rate along with domestic inflation makes matters worse. If it does not steralise its exchange market interventions, it risks worsening the inflation caused by food inflation. So actually the fact that it cannot do much to reduce food price inflation also limits its capacity to handle fluctuations in the exchange rate. This is the primary reason why RBI has not been able to do much about the falling rupee lately. Now what is the way out of this mess?

It seems the only way out is to think hard about the real reforms that are required to reduce the severity of supply shocks and not ask the monetary policy to do all the work through its limited monetary policy tools. Food price inflation is not going to reduce unless the food grains policy is reformed and unless this happens RBI will not be able to do its job of managing money supply and its effects on inflation.The next important question is will the propose retail reforms help in any way to correct the food grain policy failures and ease food inflation?

The solution seems to be more long term than immediate. What is apparent from the above discussion is the limits on RBI’s ability to tame inflation and manage the exchange rate simultaneously. Food inflation being this limiting factor, it has become important to completely rethink the way the system of food grain policy is managed. Basu (2011b) makes a persuasive argument for one such solution. As a part of the solution, he suggests establishing a Standard Operating Procedure allowing intervention in the food market based on the current market price. As such policy is a rule based policy, it avoids the pitfalls of setting policy by discretion ( the famous rules vs. discretion debate) and hence stands strong on the grounds of economic efficiency. There are many other details of the policy which form an integral part of it, but an important point to note is that in itself poor storage facilities do not seem to be the primary reason for food price inflation. According to Basu, the reason why the FCI interventions do not seem to be effective is because they have a dampening effect on the food oftake which does not go well in case of shortage.

Given this analysis, would allowing foreign retailers with 51 % equity help reduce inflation? The requirement of back end investment in storage facilities may reduce wastage and hence have a somewhat favorable effect on the prices (at least the ones which farmers receive). How much of these efficiency gains would be passed on to the consumers will depend on the degree of competition between these retailers. So it seems the consumers as well as to some extent small farmers would stand to benefit from their entry. Also, because the government still would have the right to procure food grains, it would still be in the position to even out the market price fluctuations.  What about the small traders? There would obviously be some restructuring in the retail sector. However, it is hard to imagine the small traders completely vanishing.

Many of these small traders provide short term credit to buyers. This is important when there are many who would not qualify for a standard credit card. Secondly, labor being cheaply available, these shops are in a much better position to provide incentives like home delivery to buyers. Big retailers tend to require more space and have significantly less number of branches per consumer. Whereas small traders are numerous and hence would score much higher in terms of accessibility than the retail counter parts. I am sure one could think of numerous other such reasons, but the point is that there will not be a significant effect on number of small traders after the foreign players are allowed in. If at all there seems to be a strong argument for retail reforms being complimentary to government’s efforts towards controlling food inflation. I think RBI would certainly like that!

 

Basu Kaushik, India’s Food Grain policy, Economic and Political Weekly, February 29 2011b.

Basu Kaushik, Understanding Inflation and Controlling it, Economic and Political Weekly, October 8, 2011a.

Gokarn Subir, Food Inflation: This Time it’s Different, Kale Memorial Lecture, Gokhale Institute of Politics and Economics, Decemebr 9, 2011

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