Challenging the poverty dimension of inflation: Economic Times 13th July 2011

A perverse, yet novel reason put forward to explain high inflation is that the poor are eating more as they are becoming less poor. The Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) has been extolled for being responsible for higher consumption, which in a way is a vindication of high inflation. The extended logic used here is that if the poor are eating more and we are paying high prices, then there is nothing amiss.

There are two thoughts here. The first is that higher demand per se, especially of food items, has to be met by augmenting supplies; and this holds for any good or service. If people want more mobile handsets, industry produces more of them, which leads to lower prices.

Therefore, ideally if people are less poor and demand more food, then we should produce more food at a lower cost. This is the duty of any economy that works and hence we cannot sit back and take pride in such a development as it is a reflection of the failure of the system to deliver if there are persistent supply imbalances. However, for the sake of argument, let us suppose that this theory has a basis and prima facie makes sense.

This leads to the second issue. Do the numbers really add up? The MGNREGS allots around .`40,000 crore on an annual basis, and while the code speaks of an allocation of 60:40 for wages: materials, it has turned out to be 70% for wages. Therefore, there is an additional income of .`28,000 crore. Let us suppose that all this money is actually spent and nothing is saved as the people are poor and think only of the present. Here one cannot be sure whether or not this income will lead to additional spending or will merely substitute other sources of funding.

This is so because on an average, the MGNREGS in reality provides 37 days of employment to households when they are entitled to 100 days, which means that this becomes an income supplement when they are between two harvest seasons. In the extreme case, it will fully substitute other sources of income or else they will spend the money progressively on non-food items.

Now, the consumption pattern in the country points towards around 36% of expenditure going into food items and another 7% or so into clothes, which would be the areas the farmers would be looking at. This means that around 85% of their incomes would go into food as an approximation (36 divided by 43). Total consumption expenditure on food was estimated to be .`16.20 lakh crore for the country by the CSO in FY10 while the MGNREGS money of .`24,000 crore (i.e., 85% of .`28,000 crore) will be the maximum that can be spent on food items.

Now, this amount works out to 1.5% of total food consumption (or 1.7% in case the entire .`28,000 cr is spent on food products), and considering that farm output has increased by 6.6% in FY11, one cannot really see a mismatch between demand and supply for food items in general.

At the next stage we can get down to the micro level and examine whether this theory can still hold. Out of the.`28,000 crore being spent on food products, CSO data shows that around 25% is spent on cereals and pulses, where prices showed a decline or marginal increase.

Besides, they would be covered under the public distribution system where prices have remained unchanged. Fruits and vegetables account for another 26.5% and the problem is not higher demand but high losses on account of absence of storage facilities. The Union Budget admitted that around 40% of the crop is wasted due to the absence of logistics support.

Another 21% is spent on milk products, where the higher price is due to higher cost of production (i.e., animal feed such as oilcakes and fodder) while another 12% is on meat/poultry products where prices have increased due to higher cost of animal feed. There is hence reason to believe that this higher purchasing power would not have significantly affected the demand picture, given that the problem is still on supply and cost factors.

Therefore, either way the theory that inflation in FY11 has been caused by the poor becoming less poor does not hold. The problem is on the supply side as also our inability to manage surpluses. India is traditionally in surplus when it comes to cereals, horticulture, sugar and deficient in pulses and oilseeds. The curious case here is that when production of pulses and oilseeds increase, prices move downwards and we also simultaneously lower our imports as we do not store them for the rainy day.

On the other hand, when production declines, we import more. Given that we import around 15-20% of our pulses requirement and 55% of edible oils, international prices are also influenced by this demand. Hence, inflation gets imported into our system. The wastage in horticulture is now quite well known and the country struggles to create the storage facilities to harness the production levels. Therefore, to use diminishing poverty as a factor causing inflation is neither an explanation nor an excuse.