High Food Inflation Eclipses Economic Recovery

UNCLAS SECTION 01 OF 04 NEW DELHI 002515

USDOC FOR 4530/ITA/MAC/OSA/LDROKER/ASTERN
DEPT PASS TO USTR FOR SOUTH ASIA - CLILIENFELD/AADLER
DEPT PASS TO TREASURY FOR OFFICE OF SOUTH ASIA - MNUGENT
TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN

SIPDIS

E.O. 12958: N/A
TAGS: EAGR ECON EAID EFIN ECIN EINV SENV PGOV IN
SUBJECT: High Food Inflation Eclipses Economic Recovery

REF: NEW DELHI 02482


1. SUMMARY: Despite a promising overall economic outlook, rising
food price inflation continues to pose a serious challenge to the
Government of India (GOI). Food prices increased by a staggering
19.95 percent for the week ending on December 5, the fastest pace in
eleven years. Causes of the rising food prices include both supply
and demand factors. Uneven distribution of monsoon rains this summer
resulted in a decline in production of India's fall and early
winter-harvested (kharif) crops, while India's overall economic
growth has driven up purchasing power, particularly in the rural
sector. Increased government procurement of essential commodities
and high government support prices has also played a role in rising
food inflation. The GOI has taken various measures meant to contain
food prices, including abolishing import duties for essential food
items such as rice, wheat, pulses, sugar, and vegetable oils;
imposing stocks and licensing restrictions on private trade of
essential commodities and banning futures trading. Nevertheless,
analysts predict that some of these measures will likely backfire
rather than help. Extensive restriction on private trade could also
negatively impact private investment in agriculture, further slowing
agricultural growth. In Parliament, the opposition has taken up the
offensive, criticizing the Congress-led United Progressive Alliance
(UPA) for allowing food prices to rise. Because food price
inflation is always a potentially explosive political issue in the
Indian context, further political fallout can be expected if food
prices are not contained. End Summary.

Economic Growth Accelerates
in the Second Quarter ...
--------------


2. Buoyed by manufacturing and services sectors, India's gross
domestic product (GDP) registered 7.9 percent growth during the
second quarter of Indian Fiscal Year (IFY) 2009/10 (Apr-Mar),well
above forecasts made by most government agencies and non-government
entities (see reftel). This rate compares with 6.1 percent growth
in the first quarter and 7.7 percent during the corresponding
quarter of the previous fiscal year. The surge in GDP growth was
fueled by private consumption growth, supported by government
stimulus packages and an increase in government stimulus
expenditures. The higher than expected second-quarter growth in GDP
has prompted many experts of the Indian economy to revise the
country's economic growth forecast upward to seven percent or above
in IFY 2009/10 from the earlier forecast of around 6.5 percent. IFY
2008/09 GDP growth rate reached only 6.7 percent, significantly down
from the average nine percent growth registered during the previous
three years due to the global financial crisis.


3. Agricultural GDP growth in the second quarter of IFY 2009/10,
however, was a modest 0.9 percent compared with 2.4 percent in the
first quarter and 2.7 percent during the corresponding quarter of
IFY 2008/09. There are further apprehensions about third-quarter
agricultural GDP growth due to the negative impact of the drought on
agricultural production during the fall and early winter harvest
season, which could pull down overall economic growth. Many
economists argue that since the contribution of the agriculture
sector to the country's GDP has now declined to 17 percent, overall
GDP growth is decoupling from agriculture.

... As GOI Continues Fighting
High Food Price Inflation
--------------


4. Despite the promising economic growth outlook, containing rising
food inflation continues to pose a serious challenge to the GOI.
Although India's headline wholesale price index-based inflation rose
more than expected by 4.78 percent YOY in November 09 from 1.34
percent in October 09 (since peaking at around 13 percent in early
August 2008),food price inflation continues to gallop, reaching
19.95 percent for the week ending December 5, far exceeding the
previous peak reached following the global commodity boom in 2008.
This food price figure is based on an index of food articles
compiled by the Ministry of Commerce.


5. According to experts, the wholesale price index-based inflation
does not capture the full impact of the rise of food prices as the
food group weight in the index is only around 15 percent. A more
accurate indicator of the effect that food price inflation is having
on consumers would be the various consumer price indices (CPI),
which are more heavily weighted toward food than the wholesale price
index. As of October, the three CPIs reported inflation ranging
from 12 to 14 percent, indicating how high food prices have eroded
the average consumer's purchasing power, posing a further challenge
to GOI efforts to address food and nutrition security.

NEW DELHI 00002515 002 OF 004




6. On December 16, the opposition took up the issue of food
inflation in Parliament, forcing a shutdown of the lower house (Lok
Sabha) as opposition members accused the government of not taking
action to counter sky-rocketing food prices. Local media reports
that opposition leaders claimed they would "take the issue to the
streets" if the GOI does not change policy. Trade unions, including
one Congress trade union, protested the rising food prices outside
the Parliament. On December 17, a panel of Indian MPs presented a
report criticizing the government for failing to intervene,
demanding an investigation into surging sugar prices and new
mechanisms to provide basic food items directly to low-income
consumers.


7. With food price inflation discussions taking on heightened
significance during the ongoing wQter session of the Parliament,
the GOI is in emergency mode trying to tackle the situation through
imports and more restrictions on private trade. One victim of the
current high food inflation is the Congress-led government's
election promise of enacting an ambitious Food Security Act, which
seeks to supply 25 kg of wheat or rice per month to below poverty
line (BPL) families at a highly subsidized rate of Rs. 3 (U.S. 6
cents) per kg. Implementation of the provisions of this legislation
was already posing a challenge to the GOI due to ambiguity regarding
the number of BPL families, the problem in delivering the grain to
targeted families, and the additional government subsidy involved.
Food price inflation, along with these overall implementation
problems, has forced the GOI to stall enactment of the Food Security
Act, if not completely abandon it.

Causes: Supply-Side Problems
--------------


8. Several factors, mostly supply-driven and some policy-related,
have contributed to the current spurt in food prices.
An uneven distribution of monsoon rains this summer resulted in
decreased harvests of fall and early winter crops, particularly rice
and coarse cereals, which increased prices. The poor monsoon and
pest disease problems in some crops such as potatoes also resulted
in a decline in production of vegetables, fruits and pulses, further
contributing to food inflationary pressure. Lack of a consolidated
cold chain also results regularly in large losses in perishable food
items in high summer temperatures and discourages large-scale
imports. Following a significant cyclical downturn in sugarcane
production last year and this year, sugar production has plummeted
and prices have skyrocketed. Drought conditions resulting in
reduced fodder availability, combined with high prices of feed grain
and oil meals, have led to high domestic prices of milk, poultry,
and meat products. Major organized milk vendors such as Amul and
Mother Dairy have raised their retail prices of milk and milk
products several times in the past few months. Prices of tea,
coffee, condiments and spices have also moved up steadily over
recent years due to production declines, combined with increasing
demand. The only food item price that has not gone up in the past
year is vegetable oils, due to large-scale imports of lower-priced
vegetable oils at zero import duty.

Causes: High Support Prices and
Larger Government Procurement
--------------


9. High support prices and increased government procurement have
contributed to current food price inflation as well. Although rice
and wheat production have shown a steady increase over the past
decade, reaching record levels of 99.2 million tons and 80.6 million
tons respectively in the 2008/09 marketing year, such increases in
production were achieved by offering high minimum support prices
(MSP) to farmers. Over the past five years, the wheat MSP has
increased approximately 70 percent to the current Rs. 10,800 (USD
232) per ton. For Marketing Year (MY) 2011, which is from March to
April 2010/11, the GOI has announced a support price of Rs. 11,000
(USD 236.5) per ton. MSP for paddy (rice) increased over 70 percent
to Rs. 10.300 (USD 221) per ton for superior grades, thus
establishing high market-clearing prices. There have also been
significant increases in the support price for other commodities
such as oilseeds, pulses, and coarse grains.


10. By offering high prices in 2009, the GOI has procured a major
share of India's wheat and rice production, resulting in smaller
open-market availability for these grains, further contributing to
high market prices. Paradoxically, the GOI is sitting on the
highest level of wheat and rice stocks since 2002. Over the past 18
months the GOI became the major buyer of wheat and rice in India by
offering very high support prices to farmers, discouraging private
participation in grain trade by imposing stocks restrictions and

NEW DELHI 00002515 003 OF 004


banning exports. To illustrate, GOI wheat stocks are close to the
combined wheat crops of Australia and Argentina at 28.5 million
tons, and rice stocks far exceed the combined rice stocks of all
major rice exporting countries at 15.3 million tons as of October 1,

2009. Despite this, the GOI has been reluctant to sell surplus at
below-market prices in the open market to help ease food price
inflation.

Causes: Increased Demand
--------------


11. Strong economic growth in recent years, notwithstanding a
slowdown last year due to the global economic crisis, has resulted
in increasing purchasing power in the economy. The rise in consumer
demand for high-value food products such as milk, meat, fruits and
vegetables is also contributing to the increase in prices of these
commodities. The GOI's flagship National Rural Employment Guarantee
Act (NREGA),which provides assured employment to one member of the
family for at 100 days a year at a minimum daily wage of Rs. 100,
has led to increased purchasing power. Finally, the easy credit
policy and release of overdue pay to government employees has also
contributed to increased purchasing power in both rural and urban
areas. This increase in purchasing power has led to higher demand
for food products, pushing up prices for food.

Food Price Inflation and Trade
--------------


12. Despite the sharp decline in fall and early-winter rice
production this year due to the delayed monsoon, near-record
government wheat and rice stocks should allow the GOI to make it
through the crisis without imports. To rein in the rising prices of
rice and wheat, the GOI has decided to sell both these commodities
in the open market at the GOI's support price, which is higher than
prevailing market prices. This has in fact contributed to the food
price inflation. Hence, the GOI is now considering selling wheat
and rice at lower prices. In order to conserve grain stocks, the
GOI has decided not to permit exports of wheat and non-basmati rice
in the foreseeable future, even on a government-to-government basis
as food aid. Although the GOI has permitted imports of rice at zero
import duty, no imports have taken place because the international
prices of rice are even higher than the domestic price. In the case
of wheat, despite zero import duty and lower international prices,
the GOI's overly-stringent phytosanitary norms make large-scale
imports difficult. However, some private millers in south India
have started importing small quantities of wheat in containers.


13. The GOI does not maintain buffer stocks of pulses, thus large
imports of pulses at zero duty will continue. According to
analysts, the GOI is likely to continue and even increase the
subsidy provided to public sector trading companies for imports of
pulses to offset any losses. The GOI has decided to continue the
zero import duty on crude vegetable oil imports and the low (7.5
percent) duty on refined vegetable oil imports indefinitely in order
to contain any potential increase in prices of vegetable oils
following a poor harvest. Zero duty imports of sugar will continue
in MY 2009/10 to contain the rising prices of sugar. There is
little the GOI can do to contain rising prices of vegetables and
fruits due to supply side constraints. However, a duty reduction on
vegetable and fruit imports, which are currently subject to more
than a 30 percent import duty, would possibly encourage increased
imports and expand free market supplies.

WHAT NEXT? GOI'S NEXT STEPS
--------------


14. Because the current food price inflation is largely
supply-driven, the government is making an all out effort to
increase agricultural production in the winter (rabi) season by
providing various input subsidies and soft credit support to
farmers. As hoarding (large scale speculative stock holding of
commodities) and black marketing by private traders are considered
to be some of the reasons for high domestic food prices, the GOI has
encouraged state governments to impose stocks limits and price
controls on private trade dealing in rice, paddy, pulses, sugar,
edible oils, and oilseeds under the Essential Commodities Act.
Accordingly, many states have imposed such restrictions.


15. COMMENT: With most of the food inflation supply-side driven,
there are no easy or quick fixes for the GOI to reign in rising food
prices. The GOI is likely to try measures such as continuing the
ban on futures trading of agriculture products, placing further
limits on private trade, making efforts to increase rice production,
or tightening monetary measures. However, as with most GOI efforts
to date to manage the agriculture sector, many of these measures

NEW DELHI 00002515 004 OF 004


will likely backfire. Instead of helping to control the food price
inflation, the measures will reduce open market availability,
resulting in higher open-market prices, slowing of agriculture
growth and slowing of growth in the overall economy. Because food
price inflation is a volatile political issue in the Indian context,
a significant increase in attention and continued criticism of the
UPA-led government from the opposition can be expected if food
prices are not contained. END COMMENT.


ROEMER