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Saturday, March 10, 2007

Inflation - the ripple effect spares none

I have a lot of interests, so much that I lead a slash lifestyle. My theory is that half of what I seed may not sprout, so keep the widest wingspan. But Economics, with its theories of preserving the created wealth has never been my favorite. I would say " if I know how to create wealth, I know a thing or two about how to keep it as well" !
Lately though, with inflation hogging the limelight, I had a change of mind.

I was reading an article today (“Farms are not islands”) in The Economic Times by Narendar Pani on why it’s essential to improve the ability of farming families to absorb risk. Hey, wait a minute...why only the farmer's family and not mine ? I began to wonder.
The original article has been a long one. I’ve made it in a Q & A format so that it makes sense to you and you don’t drop off midway.

Q. Why did India's budget 2007 focus so much on agriculture ? Unusual ?

Agricultural production has been under pressure for a while, but food shortages are now beginning to affect prices. Agriculture which contributes less than a fifth of the GDP has to provide livelihood for around three-fifth of the population that is dependent on it. It is this imbalance which is threatening to spike even the famed SEZ policy of the Government. Yes, it’s a bit unusual since normally the Budgets indulge corporate sector and industry more than agriculture.

Q. What is the immediate challenge ?

The immediate challenge is on the food front and to arrest the growing number of farmer suicides. Shortfalls in farm production have been allowed to affect food supplies and hence prices. The Finance Minister’s response in the budget has been to step up allocations towards Irrigation and revive other Green Revolution (GR) measures.

Q. But we have farm subsidies ? What led to this grim situation ?

The problem with previous GR strategy has been the decision by the state to take out the risk of collapse in prices. The Government offered the farmers remunerative prices ("support prices") and a guaranteed procurement of their production in case the open market could not absorb all of it. They borrowed from the Banks, acquired GR technology, produced as much as they could without worrying about glut. All this meant huge state subsidy to farmers and was manageable so long as there was a food shortage – since prices in the open market managed to stay above the support prices and state did not have to procure too much as there was market demand. This lasted till the situation turned to surplus and market prices declined, when the state had to procure at above market prices pushing up the food subsidy bill.

Q. What were the other obstacles in the system ?

Another shocker was that farmers produced crops based on what government offered instead of genuine market demand. When input costs grew, there was a constant demand by the farmers for upping the support prices. In times of abundance, huge volumes were offered for procurement - states simply had no money to pay for it either. Governments normally budget for a modest growth in subsidy and not for relentless demand for hike in support prices from farmers. This led to a situation when states had to withdraw the support prices altogether. Instead of trying to develop market making skills and rein in the subsidy bill, the Government closed the only safety valve available to the hapless farmers.

Q. What is so unusual about it given that every market has its own cycle ?

Any commodity is produced after assessing the level of market need and demand. The tracking errors can be corrected by appropriate marketing efforts ( if supply exceeds demand) or by raising funds for scaling up ( when demand exceeds supply).

The anomaly here is that farmers are forced to play blind. Their choice of crops is influenced by prices before they start sowing since they have no way of figuring out what it would fetch post harvest because of the intervening time lag. This leads to acreage allocation imbalances for different crops, results in a glut and price crash. So next year, farmers switch out of that crop leading to a shortage, and demand pushes the prices up. This cycle of abundance / shortage caused by default is not quite the way an efficient market should function. We’ve been an agrarian economy for over centuries and it’s time that we adopt efficient market practices. Developed markets have built-in systems for a realistic demand forecast backed by effective supply chain which leads to efficient price discovery.

Q. which calls for a futures market ?

Precisely. The way out of this lag is offered by the futures market. If a farmer knows what price he would get after harvest, he wouldn’t plan his crop based on price at the time of sowing.

Q. Why not have it then ?

We have it already, but is not efficient enough to achieve the desired end. The missing link is the tracking mechanism between futures market and the farmer’s ability to discover appropriate future prices of crops on the basis of sowing patterns. When a crop is sown beyond a limit, future prices will decline and farmer should be forewarned of the impending glut. Since this vital link is missing, the commodity futures market is dominated by pure-play speculators that trade on technical support and resistance. Thus instead of focusing on efforts to establish the link between the farmer and the futures market, our politicians often shoot the messenger by banning the futures trading itself – out goes the baby with the bathwater !

Q. Where does that leave the farmers ?

Farmers now are left high and dry. Neither support prices nor a futures market leaves them to absorb the whole risk. They have no way to know what prices their harvest would yield at the time of sowing. Since land is also in short supply, the risk is doubled. Scanty water resources deprive the farmer of going in for more than one crop. Since the percentage of population dependent on agriculture is not declining in tandem with the sector’s share in GDP, the buffer available for the farmer to absorb the risk is under threat. These imbalance chokes up the farmer’s finances, forces him to mortgage his land to unscrupulous loan sharks just to get by. Left with no income, the farmer often defaults on the loan and eventually gets evicted from his land which is his only means of livelihood. This often leaves to starvation or worse, suicides.

Q. That’s terrible. We need to arrest this trend before it has its spill over effect on the economy as a whole ?

It’s already fairly widespread. The urban people are already feeling the heat of high prices for vegetables, groceries and grains. It has even led to the fall of Amrinder Singh Government in Punjab.

Q. What options we have besides the routine incremental allocations made by the Government towards agriculture and irrigation in the Budget ?

Firstly, we must reduce the numbers dependent on agriculture even as we try to introduce a second GR or other innovative risk control measures. Secondly, the National Rural Employment Guarantee Scheme (NREGS) should be able to provide job to at least one member from the farmer’s family not just in state projects but also in the industry – by providing training to the rural people and incentives to the private sector. Another effective step could be by extending reservation within the existing quota to include rural farming family members belonging to those communities.

Q. why do you call it “the Ripple effect that spares none” ?

Argentinians and Indonesians have experienced it during their market meltdown in the mid 90’s – when a dozen eggs cost $100 during those days of hyper inflation. Bank accounts were frozen across the board, supplies were and the poor suffered alike. The ripple effect spared none.

There’s this indifference I'd noticed with the generation X and Y that the agriculture policy doesn't concern them since they were not farmers. For them, it is an issue between the farmers and the Government. They'd overlooked the fact that so long as we have a fully functional metabolism, we all are going to need food and that comes straight from the farm. Farther we are from the farm, more we will have to pay for food and that’s the truth.
Voila, when even the Government has stirred, the situation must be real bad...!

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