FOOD INFLATION IN INDIA: CAUSES AND CONSEQUENCES

Abstract

Average food inflation in India during the period 2006-2013 was one of the highest among
emerging market economies, and nearly double the inflation witnessed in India during the previous
decade. In this paper, we analyse the behaviour and determinants of food inflation in India. We find
that both demand and supply factors have contributed to the recent surge in food inflation in India.
On the demand side, we test the often-cited hypothesis that rising per capita income and
diversification of Indian diets has raised the demand for high-value food products and thereby added
to inflationary pressures. We find that rise in demand, relative to the supply of a commodity, results
in upward pressure in commodity prices. Moreover, rise in prices of key inputs, minimum support
prices and fiscal deficits have also impacted the prices of various commodities. Agricultural wage
inflation is found to be a universal driver of food commodities inflation, as well as the aggregate food
inflation. The contribution of agricultural wages has increased significantly in the post-NREGA era.
Our analysis indicates limited role of fuel and international prices. Finally, results suggest significant
pass-through effects from food to non-food and to the headline inflation.

1. Introduction
 India experienced one of the highest rates of food inflation among emerging economies at an
average rate of more than 9% during the period 2006 to 2013. Moreover, the rate of increase in food
prices during this period was nearly double that witnessed in the previous decade. While India has
witnessed sporadic spurts in food inflation, episodes of such persistently high inflation have been
rare. The welfare impact of such high rate of food inflation is bound to be significant given that on
average, food accounts for 48.6% of overall expenditure in rural areas and 38.5% in urban areas.
The proportion is significantly higher for 362 million or 29.5% of the population living in abject
poverty.1 On average, the bottom three income deciles in rural areas devote 60.4% of their total
expenditure on food products while food accounts for 56.5% of total expenditure in urban areas.
Given that this section of population already spends a large proportion of their income on food, they
are generally unable to divert additional expenditure on food to neutralise the impact of food inflation,
thereby aggravating food and nutrition deficiency.

In this paper, we empirically evaluate some of the major drivers of inflation. The rise in
international food prices in 2008, and again in 2010, provides a backdrop where international prices
could have influenced domestic prices, especially of tradeable products. The costs of various key
agricultural in- puts have also increased manifolds in recent years. We estimate the impact of rise in
prices of selected agricultural inputs such as fuel and agricultural wages on food prices. We analyse
the contribution of key input price inflation and global food price inflation to domestic food inflation
(aggregate and components) in a Structural Vector Autoregression (SVAR) framework, taking into
account the dynamic inter-linkages among these macroeconomic indicators, using monthly data.

An often-cited reason for the recent surge in food inflation is that rising per capita income and
diversification of Indian diets has raised the demand for high-value food products like milk, eggs,
meat, and fish relative to supply, and thereby adding to inflationary pressures. We estimate
aggregate demand using household survey data of the National Sample Survey Organisation
(NSSO) to test the validity of this hypothesis.

To gauge the role of some of the government policies as drivers of food inflation, we evaluate
the effects of rise in procurement prices on wholesale price of various food commodities in a panel
regression framework, using annual data. Finally, we evaluate the extent of transmission of food
inflation to non-food and aggregate inflation.

Our main findings include that high food inflation in India during 2006 to 2013 was a result of
various factors. On the cost side, we find that the inflation in agricultural wages is a universal driver of
food commodities inflation, as well as the aggregate food inflation. The contribution of agricultural
wages has increased significantly in the post Mahatma Gandhi National Rural Employment Act
(MGNREGA) era. Fuel inflation has a moderate impact on food inflation and the extent of the effects
vary across commodities. Significant pass-through effects from global prices are found for tradeables,
such as sugar and edible oil. On the demand side, we find that demand has persistently outstripped
supply in the case of pulses, meat and fish, while a positive gap between demand and supply is
perceived for milk and vegetables in the recent years. Supply has been persistently higher than
demand for cereals (except in 2010, following a drought in 2009) and for fruits. Overall, rise in
demand, relative to the supply of a commodity results in upward pressure in commodity prices.

Minimum Support Prices (MSP) are also found to be important drivers of food inflation in
India. The rate of increase in minimum support prices has a significant impact on next years
Wholesale Price Index (WPI) inflation. The extent of the impact is highest in the case of pulses and
sugar followed by rice and wheat.

Finally, we find that food inflation has a strong and significant pass-through effect on non-
food inflation, as well as on the headline inflation in the country.

Our results indicate that overall, both demand and supply factors have contributed to recent
surge in food inflation in India. However, looking deep into the components, it seems that rise in cost
of production and procurement prices are the main drivers of inflation in cereals. Inflation in milk,
vegetables, and meat and fish are primarily driven by increase in cost of production and rise in
demand relative to the respective supplies. Input cost inflation, positive demand-supply gap and hike
in procurement prices are the major factors behind high pulses inflation. Agricultural wage inflation
mainly drives inflation in fruits. Global inflation induces upward pressure on prices of edible oil and
sugar, while rise in MSP is an additional factor driving sugar price inflation.

Our paper makes a contribution towards understanding of how various cost- push, demand-
pull, global and policy related factors contributed to food inflation in India, in a unified framework and
their implications for the over- all inflationary scenario of the economy. Furthermore, this study
attempts to fill an important void in the literature by providing a rigorous empirical test of the long
debated hypothesis that shift in demand towards high value food items relative to their supply is a
driver of inflation in high value food components in India.

In the remaining paper, Section 2 focuses on the trend and structure of the food inflation in
India in recent years. Section 3 reviews the literature on causes of food inflation globally, followed by
the discussion specific to India. In Section 4, we evaluate the various factors that have contributed to
food inflation. These range from rise in price of inputs to rising demand supply mismatches and to
some government policies. Section 5 evaluates the extent to which food prices have influenced non-
food prices. Finally, Section 6 concludes the paper.

2. Food Inflation: Trend and Structure

Globally, consumer prices are primarily used to measure inflation. However, prior to 2011,
India did not have a unified Consumer Price Index (CPI, combined). Apart from the new unified CPI
for all India level, there are four different consumer price indices, which correspond to different
segments of the population - industrial workers, agricultural labourers, rural labourers and urban non-
manual employees. Thus there is a lack of historically comparable data. Much of the analysis on
inflation in India, including Mishra and Roy (2012), and Nair and Eapen (2012), has employed the
WPI. However, the WPI suffers from several limitations. Firstly, the WPI is neither a producer price
index nor a consumer price index. Moreover, it does not include services sector and is subject to large
revisions. Finally, a major difference between the new unified CPI and the WPI is the weight accorded
to food articles. While food articles and food products have a weight of 26.9% in the WPI, it has a
much higher weight of 49.7% in CPI. Despite these shortcomings, we employ WPI in this study for two
main reasons. First, various versions of the CPI, including the all-India index continues to provide
much more aggregated data than required for our analysis. Second, historical data on the all-India
CPI index is yet unavailable.

Figure 1 highlights the long-term trend in food inflation. It is evident that over the last three
decades, India has witnessed very diverse rates of food inflation rates. Using the methodology
developed in Bai and Perron (1998), and modified in Zeileis et al. (2010), we are able to identify 5
major structural breaks in food inflation series. Thus there are 6 distinct phases of food inflation. The
most recent phase of high inflation started in June 2008, and is continuing since then, although there
has been a perceptible decline in inflation since January 2014. Nevertheless, the average inflation
during this period at 10.4% was only marginally less than Phase II when it breached 11%. However,
the duration of the most recent phase at 76 months is significantly longer than Phase II, which lasted
for 54 months. Thus inflation in most recent period has been quite persistent, which is an increasingly
worrying sign.

Figure 1: Trends in Food Inflation and Structural Breaks

 25%

20%

15%

10%

5%

0%
Apr-83 Apr-87 Apr-91 Apr-95 Apr-99 Apr-03 Apr-07 Apr-11

-5%

We formally test the persistence in food inflation by estimating a simple autoregressive

process on monthly year-on-year inflation rate, where inflation is regressed on its lags. The sum of the
auto-regressive coefficients provides the degree of persistence in the series. The optimal lag length is
selected by using the Schwarz Bayesian Information Criterion (SBIC). We repeat the process for the
entire sample as well as the six phases identified above. The results are reported in Table 1. The sum
of auto-regressive coefficients shows that that there has been a steady increase in the persistence of
food inflation across the periods since 1990, with the most recent phase from July 2008 to October
2014 exhibiting the maximum persistence. Thus the factors influencing food and non-food inflation are
getting increasingly entrenched, and any positive shock to inflation will continue to have an impact for
a much longer time.

Table 1: Persistence of Food Inflation

Apr-83 Apr-83 Apr-90 Nov-94 Jun-99 Jan-04 Jul-08

to to to to to to to

Oct-14 Mar-90 Oct-94 May-99 Dec-03 Jun-08 Oct-14

I Month Lag 1.704*** 1.816*** 2.147*** 2.196*** 1.865*** 1.804*** 1.472***

(15.66) (13.94) (15.75) (14.99) (14.05) (11.93) (8.752)

2 Month Lag -0.919*** -1.116*** -1.690*** -1.951*** -1.265*** -1.039*** -0.598**

(-4.637) (-4.374) (-5.113) (-5.663) (-3.813) (-3.459) (-2.423)

3 Month Lag 0.151* 0.198* 0.413* 0.955*** 0.240 0.301 0.136

(1.844) (1.840) (1.835) (2.754) (1.620) (1.176) (0.645)

4 Month Lag 0.0533* 0.092* 0.109* -0.219* 0.140* -0.0774* -0.0163

(1.645) (1.873) (1.790) (-1.869) (1.770) (-1.616) (-0.130)

Sum of Coefficients 0.989 0.990 0.979 0.981 0.980 0.989 0.994

Observations 376 80 51 51 51 50 73

R-squared 0.989 0.993 0.997 0.992 0.979 0.994 0.980

Source: Authors Estimates

Next, in Figure 2 we highlight the major contributors of inflation during this period. During the
most recent phase i.e. the period from July 2008 to October 2014, when food inflation averaged over
10%, milk was the biggest contributor with an average inflation of 11.8%, and accounted for nearly
16% of the overall inflation. This was followed by eggs, meat and fish, which accounted for 15% of
overall food inflation. At 13.3%, cereal was the next largest contributor followed by fruits, vegetables
and sugar, with each of these accounting for around 10% of the inflation.

3. Literature Review

In this section, we briefly review the existing literature regarding the factors driving high food
inflation. We first focus on the literature identifying the drivers of food inflation globally before turning
our attention to key determinants of food inflation in India.

During the last decade, the global economy witnessed two distinct episodes of surges in food
prices. The first spike took place between November 2006 and August 2008, when monthly food
inflation averaged 54.4% while the second surge occurred between October 2010 and August 2011,
with a monthly average inflation of 33%.

Over the past few years, several studies have delved into the causes of the surge in prices in
these episodes. These studies have identified a number of drivers of food inflation including biofuel
demand, rapid growth in some of the emerging economies exacerbating demand for food, shocks to
money supply, stockpiling and trade restrictions in some of the economies and speculation in
commodity futures markets. However, the conclusions of these studies vary significantly.

A major factor identified as explaining the surge in food prices is increased biofuel production,
driven by generous subsidy programmes to offset use of fossil fuels, leading to food commodities being
diverted for use as biofuel feed stocks. This has created a direct competition between food and energy
markets. Mitchell (2008) argues that biofuel production from grains and oilseeds in the US and the EU
accounted for as much as two thirds of the price increase in these commodities between 2002 and 2008. In
sharp contrast, Gilbert (2010a) finds little evidence that the price spike during this period was driven by
heightened demand for grains and oilseeds as biofuel feed stocks. Several studies have looked at the
change in grain prices by simulating an increase in production for biofuel. FAO (2008) compares a scenario
where biofuel production will double by 2018 with one where bio- fuel production will remain at its 2007
levels, and finds that in the latter case grain prices would be 12% lower while wheat and vegetable prices
would be 7% and 15% lower, compared to the baseline scenario. In a similar study, OECD (2008) finds that
eliminating biofuel subsidies would result in vegetable oil prices being 16% percent lower than the baseline,
while grains and wheat prices would be lower by 7% and 5%. Comparing the rapid increase in demand for
food crops as biofuel feed stock between 2000 and 2007 with more subdued increase in demand from
1990 to 2000, Rosegrant (2008) finds that the increased biofuel demand during the latter period, accounted
for 30% of the increase in weighted average grain prices. The impact ranged from 39% in case of maize
prices to 21% and 22% of the rise in rice and wheat prices. Freezing biofuel production at 2007 levels
for various crops used, as feedstock would result in a decline in maize prices by 6% by 2010 and 14%
by 2015.

A substantial literature has argued that excess liquidity and speculation have been important
determinants of commodity prices. Excess liquidity, due to the low interest rate environment in
developed countries, resulted in a lot of new money chasing too few assets and eventually found its
way into commodity markets, thereby causing a speculative bubble (Baffes and Haniotis, 2010).
Again, the empirical evidence on the impact of speculation on commodity prices has been mixed. IMF
(2008), using empirical methods, conclude that although financialisation may have increased the co-
movement between some commodities, no apparent systematic connection is found to either price
volatility or price changes. Sanders et al. (2010) find very little evidence of a relationship between
trader positions and market returns, and thus, do not agree with the assertion that speculation has led
to bubbles in agricultural futures prices.

In contrast, Gilbert (2010a) finds that in the United States, investor activity had insignificant
impact on metal prices, but in the case of soybeans, future positions of index providers have a strong
effect on prices. However, the study failed to find similar evidence for other products including corn,
soybean oil and wheat. Gilbert (2010b) further evaluates the role of speculators in causing the
commodity price boom between 2006 and 2008, and finds that monetary and financial activities have
affected food prices through the index futures investment channel.
 Another proximate determinant of food inflation identified in the literature is the surge in
demand for grains in countries such as India and China, which experienced high growth in the recent
decade. Krugman (2008) points out that the rise in per-capita income in several emerging markets
has shifted the dietary habits of the citizens towards meat, which in turn has raised the demand for
grains as animal feed. At the same time, the high growth in these economies has made them more
energy intensive and thereby increased their demand for fossil fuels, whose prices also witnessed a
steady increase, and which is a major input for agriculture. Wolf (2008) present the same argument
pointing out the shifts in land use in response to rising demand for meat and related animal feed has
reduced the supply of cereals available for human consumption. However, Baffes and Haniotis (2010)
refute this line of argument pointing out that growth trends of population and income over the past
decades, along with those of demand for food commodities, do not exhibit a discernible increase in
food demand growth in recent years. Moreover, in India and China, the period between 2003 and
2008 witnessed a higher growth in consumption of maize and soybeans compared to the period
between 1997 and 2002, but no such trend was observed in case of grains, meat and dairy products.
Alexandratos (2008) also concludes that the combined domestic consumption of both wheat and rice
in India and China has continued to decelerate during recent years of price rise, similar to the trend
observed some time earlier. While meat consumption has been rising, especially in China, the trend
shows no acceleration in recent years, thereby unlikely to have contributed significantly to the global
price increases. Moreover, in both India and China, feed use of cereals per capita flattened out in the
years prior to the surge in prices.

Restrictive trade policies pursued by some of the major exporters of food commodities to
enhance their domestic food security also impacted global food prices given the thin markets for such
commodities. Timmer (2008) highlight the major tax and quantitative export control measures taken
by major rice exporters. While Thailand kept its border open and did not restrict rice exports, Vietnam
introduced a ban on rice exports in early 2008, which continued till July. Similarly, Alexandratos (2008)
notes that bot h China and India, which have been net exporters of cereals, witnessed a steady drop
in export balance from 22 million tons in 2002 to only 5 million tons in 2007. Much of the decline in net
exports was driven by China, which witnessed stock depletion during this period due to a decline in
domestic production.

Having focused on major drivers of food inflation worldwide we now shift attention to the
major determinants of food inflation in India. Mishra and Roy (2012) provide a detailed analysis of
some of major issues related to food inflation in India. The paper divides the various food products
into four categories based on their inflation rate and weights in the inflation basket. Based on this
analysis they identify milk, sugar, cereals, edible oil, fruits and vegetables to be the major contributors
to food inflation. The paper then discusses the short- and long-term factors that have influenced
prices for these products. Among the long-term factors, the most common one pertains to increase in
demand for these products (except cereals) due to rising per-capita income and population growth
that is not matched by a commensurate increase in supply due to low productivity. The short- term
factors have focused on negative supply shocks emanating from adverse weather shocks, changes in
support prices, policies related to stocking and futures trading and temporary trade policies.

Similarly, Nair and Eapen (2012) undertake a commodity-wise analysis of inflation. The paper
focuses on pulses, fruits, vegetables, sugar, spices, meat and milk, and concludes that supply side
constraints and cost escalation factors were the major drivers of inflation in most commodities. Barring
milk, the paper finds no evidence supporting the view that consumption shift towards high value
agriculture products has been driving prices up. Chand (2010) argues that the rise in food prices in
recent years was a result of a supply shock driven by the drought of 2009 and low production growth
in 2008-09. Rising share of food crops being diverted to export markets as high global prices made
exports more lucrative. Another factor, also contributed to the rise in domestic prices. Apart from
reducing the amount entering domestic supply, it also facilitated the transmission of some of the
increase in global price to domestic price.

In contrast, Kumar et al. (2010) argues that the structural reason for food price rise is the
rising gap in per-capita income, which resulted in rise in demand for food products. This, stagnant per-
capita availability of these commodities along with rising incomes meant that the better-offs were
chasing prices to meet their demand, resulting in higher prices, and driving poor people to make do
with lower consumption. Similarly, Gokarn (2011), Bandara (2013), Gulati and Saini (2013) also point
out that India has witnessed shifts in its food basket from calorie-rich cereals to protein and vitamin-
rich diets, such as pulses, milk, egg, meat and fish and vegetables, causing upward pressure on
prices of these commodities.

Several studies have identified the increase in Minimum Support Prices (MSPs) as a major
driver of inflation in India. The MSP is the floor level price at which the government stands ready to
buy whatever volume of crops the farmers are willing to sell. The purpose of MSP is to ensure
remunerative and stable price environment, which is equitable and prevents the farmers from
resorting to distress sale. However, with MSPs being designed to be the floor for market prices, they
have influenced market prices, whenever the increase in MSPs has been substantial. Mishra and Roy
(2012) argue that for MSP to be effective in procurement, it needs to be set above the market-clearing
price. Hence, any increase in MSP can set up inflationary pressures in the system. Gaiha and
Kulkarni (2005) corroborate the positive effect of the combined rice and wheat MSP on the WPI.
Controlling for this effect, neither the gross fiscal deficit nor the money supply is found to have a
significant impact. Bhalla et al. (2011) point towards a strong link between MSPs and food inflation in
India, with a 10% increase in these prices resulting in 3 percentage point in CPI inflation.

Other factors identified in the literature as influencing food inflation include the widening of
fiscal deficit and consequent rise in liquidity for financing the deficit. Gulati and Saini (2013) find that
fiscal deficit is the biggest contributor in driving up food prices followed by rural wages and global
prices. Gulati and Saini (2013) and Ganguly and Gulati (2013) also conclude that the rise in liquidity in
the economy for financing the widening fiscal deficit in the post crisis period, and hike of procurement
prices also contributed to rising food inflation in the country.

The sharp increase in rural wages since 2008 have also raised the cost of agricultural
production substantially (Gulati et al., 2013), The increase in rural wages coincided with the universal
implementation of Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), which
promised 100 days of paid work to adult members of every household, thereby raising the reservation
wage. Phased deregulation of administered fuel prices is also likely to transmit rising fuel prices to
fertiliser and transport costs, pushing up food inflation in India (Bandara, 2013).

REVIEW OF LITERATURE
However number of studies have been conducted in the form of surveys and research work done on
food inflation. An attempt has been made by the researcher to understand and acknowledge the work
of various researchers in the field of food inflation and consumption.
Increasing trend in primary food articles:
Chart -1 represents the decade wise trend in the primary food articles in India from year 1954- 2011.

Source: NSSO Surveys

Chart 1. Decade wise average inflation
Shift in Dietary Habits towards Protein Foods:
A distinct feature of recent food price inflation has been the sustained price pressure in protein rich
items (milk, pulses, fish, meat and eggs). Inflation in protein rich items has generally exceeded both
headline (WPI) inflation and inflation in primary food articles (Chart-2).

Source: NSSO Surveys

Chart 2. Inflation in Food Articles and Overall Inflation
One would expect, the share of food in total expenditure has declined over successive rounds of
NSSO surveys alongside increases in per capita income, consistent with Engel s Law
(Chart-3).

Source: NSSO Surveys

Annual Food Inflation Trend in India:

 Chart 4. Annual food inflation trend in India
Production and per capita availability of milk in India:
Indias population is predominantly vegetarian, milk form an essential component of the human diet
and no other natural food meets the nutritional requirements better than milk. In India, people used to
consume milk as part of their daily diet and hence the consumption of fluid milk is very high. India
ranks first in world milk production, increasing its production from 53 million tonnes in 1990-91 to
about 121.7 million tonnes in 2010-11 (Table-2).The per capita availability of milk has also increased
from 176 grams per day in 1990-1991 to 276 grams per day in 2010-2011. It is still low compared to
the world average of 279 grams/day, as per FAOSTAT (Food and Agriculture Organization Statistical
Database). India's milk production increased over 4% annually during 2000-01 to 2010-11 surpasses
the 1.6% growth in population; the net increase in availability is around 2.4% per year.
Table 2. Production and per capita availability of milk in India
Per Capita
Production
Year Availability
(Million Tonnes)
(grams/day)
1990-91 176 53.9
2000-01 220 80.6
2005-06 241 97.01
2006-07 246 100.9
2007-08 252 104.8
2008-09 258 108.5
2009-10 263 112.5
2010-11 276 121.7

Source: Department of Animal Husbandry, Dairying and Fisheries, Ministry of Agriculture