Link between interest rates and food prices is...

Nov 7, 2011

In this issue:
» The alarming half of fiscal deficit
» India Inc in a forex fix
» Govt. not to be blamed for higher petrol prices?
» No magic wand to boost US
» ...and more!
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Food prices in India have been on an upward trend. And they are not showing any signs of coming down in the near future. In fact, the latest reported figure on food inflation has been as high as 12.21%. It is the highest recorded reading since January this year. Considering that food forms a whopping 14% of the Wholesale Price Index, it is little wonder that inflation rates have not really come down either. But since January, the Reserve Bank of India (RBI) has raised interest rates consistently with the hope of bring inflation rates down. So why is it that they seem to have no effect on the inflation rates and more importantly on the food part of the index?

A leading daily has tried to answer this question. There are two main reasons for this. The first is higher rural income. Rural income has shot up quite substantially over the past few years. A main reason for this has been the increased focus on rural schemes like the NREGS (National Rural Employment Guarantee Scheme) that have led to a significant flow of money into the rural areas. Such schemes have led to larger disposable incomes in the hands of the rural population. This in turn has led to higher demand for food from them. And it's a known fact that when demand rises, prices will go up if supply does not match the increase.

This leads us to the other part of the equation. The supply side. On the supply front, the supply of food has not really kept pace with the demand. Reducing crop acreage due to industrialization, pulling out of agriculture labour due to urbanization, are just some reasons due to which supply has remained constrained. In addition to this, there are environment issues like depleting water table, erratic monsoons, which have further brought supply under pressure.

And not to forget a big reason for limited supply - the supply chain bottlenecks. This has led to the wastage of large quantities of grain. And has further added to increases in prices of food. While RBI's move to raise interest rates may have helped in sucking the liquidity out of the monetary system. However, it has not really affected the food prices at all. True that the government cannot do much with regards to the environment related issues. But it can certainly help in decongesting the supply chain issues so that the food that is produced at least reaches the consumers. This would help bring down prices for sure. Otherwise, increasing the interest rates may just end up in sucking the growth out of the economy, without really affecting prices in any way whatsoever.

Do you think increasing interest rates can bring down food inflation in India? Share your comments with us or post your views on our Facebook page.

 Chart of the day
Indians love gold. There are no two thoughts on that. But the recent increase in the yellow metal's prices has just made gold dearer. At least that is what the numbers show. As shown in today's chart of the day, India's import of gold in FY11 has nearly doubled from the levels in FY07 (financial year 2006-2007). In absolute terms, gold imports have been increasing every year since FY07. Though as a percentage of GDP gold imports have eased in FY11. Nevertheless they still constitute nearly 2% of India's GDP.

Data source: World Gold Council

We all know our central bank, the Reserve Bank of India (RBI) has been trying hard for almost 20 months to battle high inflation. But even after having raised key interest rates over a dozen times during this period, the RBI has failed to reign in the monster. In order to bring inflation under control, there has to be some synch between the monetary policy and the fiscal policy. But how can monetary tightening work when there is so much fiscal indiscipline. The Government of India has not managed the budget for the first half of the fiscal year 2011-12 too well. Up till September 2011, while expenditures have been more or less at the same level as the previous fiscal, the government's fiscal deficit has already reached 68% of what it had projected for the entire fiscal. The reason for this is the decline in government's revenues. Tax revenues are not flowing in as projected. Non-tax revenues too have dried up as compared to the previous fiscal. Moreover, the second half of the year is likely to see the expenditures rise on account of increase in subsidies. All of this means that the government's ambitious fiscal deficit target of achieving 4.6% of GDP (Gross Domestic Product) in FY12 is likely to meet with failure.

As if the high domestic interest rates are not dampening enough, forex volatility is adding to companies' balance sheet woes. But this is particularly for those entities that chose to beat the domestic interest costs with forex denominated leverage. Thanks to the rupee's depreciation versus the US dollar, their cheap funding plans have now gone for a toss! Moreover, the cash strapped companies are now looking at interest costs nearly three times higher. Many companies which had raised short-term funds through FCCBs (foreign currency convertible bonds) in fact do not have the cash flows to redeem these. Hence they are inclined to refinance the debt. Ironically, most of this exposure is un-hedged. For those whose FCCB redemptions are falling due within six months to a year, the dearer dollar will mean borrowing from domestic markets to roll-over the debt. Forced to borrow at interest rates of 13 to 14%, the companies will end up shelling out nearly 3 times their earlier interest cost. Thus investors need to once again be forewarned about companies that leverage too much in foreign currency. These entities subject themselves to not just leverage risks but also foreign currency risks.

Oil marketing companies have increased petrol prices a total of 10 times in the last 16 months! Hence it comes as no surprise that the government sees fuel consumption falling in India in the medium term. With inflation hovering at double digits, GDP growth projections have been slashed. And energy demand being a proxy for a nations' development, is bound to follow. In fact, the past few months have already seen the actual fuel consumption falling short of estimates.

The Indian economy is now expected to grow at less than 8% for FY12 versus 8.5% last year. Hence, the forecast for fuel demand has been slashed by 1% to grow at 3.6%. The cut down in the demand estimates is in consonance with IEA's outlook on slowdown in global oil demand.

However, its implications on state run oil companies that sell most of products at regulated prices may vary from those on international firms. While a slow demand growth may soften crude oil prices and fuel prices abroad, a weakening rupee (against dollar) scenario will make it difficult for OMCs to cut down fuel prices. In fact, as reflected in the interim results, they are finding it tough to remain viable at existing fuel prices. Worse, the weak GDP growth may lead to lesser compensation for under recovery losses by the Government. Hence, besides coming up with economic policies to keep the growth momentum going, it's time that Government bites the bullet and undertakes substantial fuel price reforms as well.

Wish that all the uncertainty in the world could just go away? Hope that with one zap things could go back to how they used to be? Well, the Fed doesn't have a magic wand that could help strengthen its ailing economy and boost sentiment. Officials need to work hard on resolving fiscal challenges first. They admit that downside risks still remain for the economy.

In their meeting last week, American policy makers decided to keep their plans unchanged. Their two policy actions to lengthen the maturity of the Fed's bond portfolio and to keep the target federal funds rate near zero till at least mid-2013 continues. Before any further action on the policy front, officials prefer to apply a wait and watch policy to first see how these two moves pan out. Ben Bernanke however left the possibility open that the Fed could expand its holdings of mortgage debt. But no action was yet decided on the same. Thus, there is no real booster to the American economy as of now. However, if economic conditions do worsen, there is always the option of buying more mortgage back securities to help stimulate the economy.

In the meanwhile, the Indian stock markets were closed today on account of Bakri-Id. Stock markets in Malaysia and Singapore were also closed. Other Asian markets have closed the day on a weak note following the growing uncertainty surrounding Greece. China and Hong Kong were the biggest losers.

 Today's investing mantra
"Investing is laying out money today to receive more money tomorrow." - Warren Buffett

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27 Responses to "Link between interest rates and food prices is..."


Nov 21, 2011

I believe willpower of politicians IN POWER is most important.... Raising the BASE rate with such high frequency will not take us anywhere, it will leads to further increase in INFLATION on long-term . In my 17 years of BANKING experience 1st time am noticing such a inconsistency in efforts of curtailing INFLATION, they are jus trying to manage the show without any long-term vision.

Like (1)


Nov 19, 2011

Certainly not! Increasing interest rate frequently is not the answer to control inflation.The supply side need to outstrip demand and when this happen RBI & Govt. are going to learn about it.....

Like (1)


Nov 15, 2011

After reading what i have typed, i am sure several may not like it, but after visiting 20 countries, I have found that several vegetables and some food grains are dirt cheap in India comparing to other items. No wonder the farmers are so poor in India. Well the poor benefit buying the cheap vegetables but i noticed that the rich too eat the same. Except that pulses and fruits are expensive these days. In most of the foreign countries, generally veg n non veg items cost almost the same per kg. So I feel specially the vegeterians here, are in a bit of luck, until the farmer thinks of raising that too.

Like (2)

Dalip kumar Guran ditta

Nov 14, 2011

thank you

Like (2)


Nov 14, 2011

i think only RBI credit policy is not enough to control the inflation. but RBI should have think that BLACK MONEY has a great force to pull the demand & cornered the supply chain, which(Black Money) can not be withdrawn from the market by such a credit policy. and it should be noted that hiking interest rate push the cost of production & hamper the production(supply).

Like (2)

Ravndra Desai

Nov 14, 2011

The large migration of agricultural labour to urban areas, the induction of large money in MNREG, the erratic monsoon and other environmental causes are being analyzed for food inflation, but it it is not true. these causes were there all along and the economic scenario is taken the beating in recent one year. In fact the speculative forces have taken over the country's economy and the government is sitting duck doing nothing. Monetary tightening will not help, it will further deteriorate the currency as we are seeing now and that snowball into other sectors increasing economic woes further like jeopardizing the oil and energy sector. So food is not the only issue, there are other issues about the governance which this government has failed to address.

Like (2)

Ashok Rastogi

Nov 14, 2011

Food inflation ishigh due to various factors such as Poor Agriculture out put management and channelization to end-users,wastage of food items by by rich,demand increase due to rapid increase in population,erosion of cultivable land.Govt. do not have serious will power to handle it. Due lackadaisical approach they are not able to maintain sufficient inventories.Of course there has been some un -seasonal heavy rainfall in early oct.which has increased misery of people.Higher interest rate can bring down the growth of industry and some extent demand for finished products.

Like (2)


Nov 10, 2011

The food is the most essential source given by nature to survive, it is the land, hands, technique, care and quality in-puts matter to increase supply position. The real thrust on the ground is not enough to achieve higher results. The plans and schemes are changing with the change of Government. The consistency in implementation followed by periodical analysis will direct the thrust to increase supply of food products. The demand side we are adding 20 million mouths every year thus demand is surpassing the supply every minute, hour and day. The increase of interest rates will not affect the demand or the supply. The Government is utterly failing to appreciate and take remedial measures to improve supply and decrease demand on log term basis. The interest increase is absolutely wrong approach to reduce food prices.

Like (2)

Nayan Desai

Nov 9, 2011

All said is true. Interest rate hike has overall impact on all commodities. If NREGA is pursued as a valid reason for inflation it is a welcome move coz it proves that money is reaching the targeted population.However, this is in contrast to the fact that money given by GOVT for the scheme is misappropriated. Secondly, the commodities trading is the other monster which is responsible for food price increase along with poor PDS to reach food to consumer at desired time and resulting in rotting food grains in FCI godowns.

Like (2)

Akhil Banthiya

Nov 8, 2011

I Think that the suggestion given by Srinivasan in the secons last post above is can be a great measure that the government should take in order to control food inflation.
Moreover I would like to add that, instead of controling the food inflation through monetary policy; the government should focus on increasing the productivity i.e. the yeild per hectare of agri-products.
India's yeild per hectare is very low as comared to US and other developed countries. This is mainly due to difference in the quality of seeds fertilizers and technology used in agriculture in India.

Like (2)
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