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Insights from bureaucrats

the

AGRICULTURE: Agri-inflation to moderate by appropriate

policies, easing international prices

Agri growth seen at 1%+ in FY13, productivity gains need of the hour

We met the current and former Chairmen of the Commission for Agriculture Costs and

Prices (CACP) to discuss various issues relating to agriculture policy and prices. Our key

takeaways:

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One of the factors responsible for the high food inflation is very high buffer stock (in case of wheat), perhaps well above

what is required under the Food Security Bill. Expeditious taxes imposed by certain states have made it difficult for the

center to offload in the market (would result in a loss). Among other policy-related factors fuelling food inflation is the

imposition of ad-hoc import duty (in case of sugar).

While Indian prices are set just below FOB international prices, rise in the latter affects domestic prices. This is further

accentuated by the INR depreciation. Rising exports on the demand side and increasing wages on the supply side are other

macro factors responsible.

The magnitude of rainfall deficiency was limited in 2012 as compared with the 2002 and 2009 droughts. However, agri GDP

actually grew 1% in FY10, compared with the Planning Commission's estimate of 6% decline. In FY13 too, agri GDP might

grow 1%, as (1) the Rabi crop, which has ~50% share, should do well on late rains, (2) water management has improved, and

(3) the share of foodgrains in overall agriculture now stands only at 25%.

Over the medium term, a whole range of reform and policy measures need to be implemented to improve comparatively

low productivity of Indian agriculture. These include both price and non-price policies covering 4 'I's, viz., infrastructure,

incentives, institutions and information. Diversion of subsidies to investment, direct cash transfer of subsidies, focus on

technology and water, diversification of crops and allied activities, absorption of surplus labour into manufacturing and rural

non-farm sector, and institutional changes in marketing (including changes in Essential Commodities Act and APMC Act) are

of critical importance.

We hold that while agri inflation is likely to moderate, it would continue to receive upward thrust from rising input costs,

especially on account of migration of fertilizer subsidy from a producer subsidy to a consumer subsidy. We also hold that

improved policy coordination, especially among the center and the states, would usher much bigger change in Indian

agriculture. Finally, we have modeled a somewhat higher agri-GDP growth of 1.8% in our overall GDP growth projection of

5.8% for FY13 on account of a variety of factors contributing towards the resilience of Indian agriculture to drought.

I. Agri-inflation to ease by appropriate policies, softer

international prices

Very high food prices in the last two years:

In the last two years, the prices of various

food articles have increased sharply, though by a varying degree. There has been

dramatic acceleration in inflation in September 2012 as compared with September

2011 in the prices of cereals (4% to 14%), pulses (3% to 29%), oilseeds (15% to 28%)

and sugar (7% to 18%). Meanwhile, prices have moderated significantly for fruits &

vegetables (15% to 0%) and to some extent for milk (10% to 6%). For protein-based

items (egg, meat and fish), inflation remained at double-digit levels (12%) for the last

two consecutive years.

Dipankar Mitra

(Dipankar.Mitra@MotilalOswal.com); +91 22 3982 5405

Investors are advised to refer through disclosures made at the end of the Research Report.

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Varying price pressures within food groups

Buffer stock has shot up to more than what is required under

the Food Security Bill

the

Source: Govt, MOSL

Micro explanations for food inflation point to policy failures

Wheat:

In micro markets (such as Bareilly, UP and Delhi) prices of wheat and atta

(flour) have increased by 20% in just two months. However, this has got much to

do with the government building huge stocks of wheat (50m tons), well above

what is required as per the buffer stock norm and perhaps even above what would

be required under the Food Security Bill. The government is also not releasing

stocks, as the cost of procurement from Punjab at INR1460/quintal is too high due

to imposition of irrational tax by the Punjab government. Because of this, the

government will have to sell at a loss, as the market prices are lower. Exports are

not picking up either. The solution to this may lie in direct cash transfer.

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Sugar:

In case of sugar, a 10% import duty was imposed ahead of elections. This

too was done at a time when the international prices of sugar were declining. This

led to a steep increase in domestic sugar prices despite domestic supplies

exceeding demand.

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Pulses:

Because of deficient rainfall, one would have expected the prices of Kharif

pulses to soar. However, in reality, the prices of a Rabi pulse, chana (Bengal gram

or chickpea), are up 50% on 15% drop in production. This may trigger a price rise in

tur (pigeon pea) and moong (green gram) too. A weak solution could be to import

yellow pea and blend (adulterate) in besan (gram flour).

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Oilseeds:

Soya prices have gone up by 76% on news of drought in the US and

demand from Iran for soyameal. Groundnut prices could soar because of a drop in

production in Gujarat. Overall, there is shortage of edible oil.

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Macro factors impacting food inflation

International prices:

For most commodities, including rice, wheat, maize, soya

meal, eggs, meat, fish, etc, domestic prices are marginally below FOB prices.

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Rising exports:

India has emerged as the largest exporter of rice and meat. Exports

of maize and soya meal from India are also picking up.

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INR depreciation:

INR depreciation has added to the price woes, international

food prices in INR terms have gone up.

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Rising real wages:

Real wages have increased by 6.8% during the period FY08-12,

giving an upward thrust to food inflation.

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Real wages did not grow in the last decade but have been

rising sharply in the last two years

INR depreciation has added to the price woes

the

Source: Govt, RBI, MOSL

Domestic food prices are marginally below FOB prices

Source: Govt, MOSL

Price outlook moderating

Easing trend in some commodities:

International prices of agro-commodities like

palm oil, sugar, corn, soya, etc are moderating.

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Potential policy action to keep a lid on cereal prices:

If the government releases

ample wheat at INR1,285/quintal, cereal prices will slide back.

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Prices of pulses to remain firm:

Prices of certain food items like pulses are likely

to remain firm.

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II. Expect 1% agri-growth in FY13 notwithstanding deficient

rainfall

2012 deficiency lower compared to drought years of 2002 and 2009:

In 2012, the rainfall

deficiency was only 8% compared to 19% in 2002 and 22% in 2009. The regional rainfall

pattern too was more even, with a range of -4% to -11% compared with -7% to -33% in

2002 and -6% to -35% in 2009.

Rainfall deficiency was much lower in 2012 and improved

in all months

Rainfall deficiency was also more even in 2012 and lower for

most regions

the

Source: IMD, MOSL

Impact

of drought in 2009:

While the Planning Commission projected a 6% decline in

agri-GDP in FY10, it ended with a positive growth of 1%. Though rice output declined

by 10m tons and overall foodgrain output by 16m tons, agri-GDP increased because of

(1) improvements in water management, and (2) late rains helping the Rabi crop

(whose share has become nearly equal to the Kharif crop now and was 52.4% in FY10).

2012 is likely to be better:

Storage levels of 84 reservoirs are now much better than in

2009 and late rains in August and September have also improved the prospects of the

Rabi crop. While the first advance estimate predicts a 10% decline in FY13 Kharif

production, the decline appears sharper on a very high base of FY12, when foodgrain

production reached a record of 257m tons. Though rice production might fall, the

decline could be constrained by higher acreage in some states. The production of

coarse cereals is likely to be less.

Agri-GDP seen at 1% in FY13:

While some setback is likely in foodgrain production, it

constitutes only 25% of agri-GDP. Fruits, vegetables, livestock, fish, etc have a large

share in agri value of output. Overall agri-GDP might show 1% growth in FY13. Assuming

a 3% average agri-GDP growth, this translates into a 0.3% decline in overall GDP for

FY13 on account of deficient rainfall. While the GDP impact is relatively less, it would

have medium to significant impact on the livelihood of particularly deficient regions,

food inflation and minimum support prices (MSP).

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III. Medium-term plan to improve agri-growth

Importance of agriculture:

This stems from various facts such as (1) agriculture supports

52% of employment, (2) agri growth is found three times more effective in reducing

poverty than other sectors, (3) performance of the agri sector has serious implications

for food security, (4) inter-linkage to agro industry and services, (5) small and marginal

farmers constitute over 80% of the farming community in India, and (6) 4% agri growth

is crucial for 9% overall growth.

Wide variations in agri growth:

Despite its critical importance, agricultural growth has

varied across different periods. The main propeller of agri growth has shifted from (1)

area growth to (2) yield growth, mainly on account of green revolution, and now to (3)

higher price realization. However, agri-GDP growth has been far more volatile than

overall GDP growth even on a yearly basis.

Different propellers of agri-GDP growth in different phases

Period

FY51 to FY65

FY68 to FY81

FY81 to FY91

FY93 to FY05

of which

FY98 to FY05

FY05 to FY11

Agri -GDP growth

2.5

2.2

3.1

2.8

1.6

3.5

Attribute

Area growth + yield growth

Yield growth due to green revolution

Spread of green revolution

Reform period

Neglect of agriculture

Revival of growth

Source: SM Dev, MOSL

the

Comparatively low productivity of Indian agriculture:

A comparison of four emerging

market economies (EMEs) shows that over a long period, the growth in agricultural

productivity in India has lagged behind other countries including China, Brazil and

Indonesia. Factors responsible include technological breakthrough, timely access to

knowledge and inputs, farmers' integration with the market, etc. China in particular

has initiated more fundamental institutional and policy reform - its manufacturing

absorbed labor from agriculture and incentivized capital investment and technological

change.

Areas of concern:

Many concerns regarding Indian agriculture include (1) spread of

green revolution limited to irrigated areas, and there too, there is a technology fatigue,

(2) shifting demand pattern away from cereals, not matched by corresponding supply

change, e.g., in pulses, edible oil, fruits, vegetables, dairy and livestock - resulting in

food inflation, (3) steeper decline in per capita land availability, and (4) slow reduction

in the share of employment (still high at 52%).

Dynamism in recent years:

These include (1) return of growth - 3.3% in the XIth Plan,

257m ton food grain production in FY12, (2) doubling of cotton production in last six

years, (3) increase in high value agri products, (4) some rain-fed areas showing high

growth - like 9% in Gujarat, (5) improved terms of trade, (6) pick-up in exports (last

year - rice: 10m tons, wheat: 2.5m tons, sugar: 3.5m tons, cotton: 4m bales), and (7)

both private and public investments in agriculture have grown.

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Pick-up in agri-GDP in XIth Plan helped lift the overall GDP too

India is diversifying towards high value agri products (% of

total value)

the

Source: CSO, MOSL

Reform for 4% agri growth:

This has two components (1) attractive price policy - while

there has been meaningful increase in MSP in recent years, this has been eroded by

significant cost increases, especially wages, (2) non-price factors capture the four 'I's

- infrastructure, incentives, institutions and information. The Economic Advisory

Council has suggested three reforms (i) legalize tenancy, (ii) reforms in marketing,

and (iii) reforms in input subsidies. Finally, the solution might also lie outside

agriculture - including promotion of labor-intensive manufacturing and rural non-

farm employment to absorb surplus labor.

Appropriate agricultural policies:

These include recommendations in the areas of (1)

redirecting subsidies to investment (cash transfer wherever subsidy needs to remain),

(2) land and water management policy (successful in Gujarat), (3) technology (green

and white revolution, BT cotton, hybrid maize, PPP mode needed), (4) reduce yield

gap in areas and improve yields through new technology, (5) use of IT (e.g. e-choupals,

mobile phones).

Substantial increase in MSP over FY05-13 (%)

* pertains to 2012

Source: Govt, MOSL

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Need for reforms in marketing and trade

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the

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Need to address issues of over-regulation of domestic trade, agro processing,

enterprise size, and land and credit markets

Consistency in policy regarding domestic and international trade as also of the

futures market that witnessed frequent imposition of bans

Crop insurance for yield risk and futures & forwards markets for price risk

Improvement in farmers' margins, eliminating layers in the value chain

Infrastructure for storage, sorting, grading or post-harvest management

Essential Commodities Act impedes free movement of products

APMC Act maintaining monopoly of government control (amended in 17 states

already)

Multiple taxes that distort price mechanism

Institutions for aggregation, as small farming is no longer viable and may include

contract farming, self help group model, cooperative model and producer

cooperatives

Wholesale, processing and retail developing in India, with supermarket revolution

catching up - FDI in retail to be helpful

Focus on food processing to minimize post harvest losses (only 2% of India's fruits

and vegetables are processed against 23% in China, 78% in Philippines and 83% in

Malaysia).

Farmer only realizes 30% of the value of the produce

Village

Commission

Agent

15%

District

Commission

Agent

20%

Farmer

Processor

Wholesaler

Retailer

Consumer

30%

15%

5%

15%

100%

Source: Govt, MOSL

IV. Our assessment

Prices:

High food inflation in recent years has been explained through a multitude of

both demand side (e.g., protein inflation, international prices, exports, higher MSP,

etc) and supply side (e.g., rising wages, government buffer stock policies, etc) factors.

A key factor adding to input prices has been higher cost of fertilizers, which in some

cases has increased by 70% in the last two years. The fact that increasingly, producer-

related subsidies are migrating to consumer subsidies (including proposed direct

cash transfer), this factor alone would continue to lend upward pressure on food

inflation in the medium term.

Lack of policy coordination:

Apart from various instances of policy failure noted above,

it is obvious that lack of policy coordination, especially between the center and the

states, comes in the way of improving agriculture. One recent example is that while

rainfall was highly deficient in 2012, especially in early months, the sowing pattern

reflected that area under less water intensive coarse cereals has dropped by 18.5%

while that of water intensive sugarcane increased by 8%. A very advanced weather

forecasting system does not necessarily usher requisite changes at the ground level.

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Agri-GDP growth could be higher than 1% in FY13:

The first advance estimate of

foodgrain production points to a decline in Kharif foodgrain production based on

measurement of cropped area. However, this is usually revised upwards. Besides,

the rising importance of Rabi production and its improved outlook on late rains, limited

share of foodgrains in the overall agri commodity basket, increasingly drought resistant

varieties of cultivation and water management, higher investment and government

drought relief measures may result in better agri growth prospects for FY13, buffering

the expected decline in industry. We have modeled 1.8% growth in agri-GDP for an

overall GDP growth of 5.8% in FY13.

the

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N O T E S

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