MACROECONOMICS

Date: 15 12 - 15

Tackling high food inflation: Issues & Solution

Inflation is measured by CPI or WPI, by tracking the annual rate of changes in the prices.
India (government) used WPI (Wholesale Price Index) to calculate its (economic) inflation.
In which 676 commodities were chosen and divided into 3 categories, all of which have
different weightages in inflation. 102 belonged to Primary Articles category (20.12%), 19
belonged to Fuel & Power category (14.91%) and the remaining 555 belonged to
manufactured product category (64.97%).
Currently India (government) uses CPI (Consumer Price Index) to calculate its (economic)
inflation because it matter more to the consumer. CPI is broad measure of consumer prices
across different segments like energy, clothes, housing, food, etc. While inflation in most of
the segments tend to move in either direction similarly, there are segments which move
differently from the other segments & the magnitude of the movement in segments may
various with respect to each other. For example food inflation can be high whereas, fuel
inflation can be low. Thus, the food inflation may be different from the CPI.
The elementary factor that governs inflation is variation in supply and demand. Inflation is
caused by when there is increase in demand but not met by increase in supply. Inflation is
often outcome of shortages in basic goods and services, and a rapid growth in money supply
and bank credit, various types of measures relating to money supply, pricing and distribution
of commodities have been pressed into service.
ISSUES:
Taking into consideration movement of Indian Economy since independence in 1947 to
current year 2015, various factor are to be credited with inflation as whole (especially food
inflation). They are as following (points should be read keeping in mind food inflation):

Wars against China & Pakistan which emptied government coffers. Most of the
revenue earned was spend on buying defence arms and ammunition. Thus,
government of India did not have enough revenue to provide people with subsidies,

provide food schemes, invest in agriculture etc.

Increase in defence budget of the country year by year which causes more and more
revenue generated by government of India to be used protecting its soil with no
immediate threat, which causes government to charge higher taxes, increase interest
rates (lending), using less of the available resource in tackling inflation (that revenue

could be used to create buffer stock, provide subsidies, improve transport facilities

etc.).
Famine conditions which persisted & persists in parts of country (food producing) due
to no rainfall & scarcity of water for irrigation, which causes a shortage in production
of a particular vegetable, cereal (country level), and which causes increase in demand

of food (general) in & around that area.

Hoarding, Black Marketing & Smuggling which creates artificial shortage of food

(crop, vegetable, pulses etc.) when in reality it isnt so.

Failure of either Rabi or Kharif crop or both due to pest infection, low rainfall, too
much rainfall etc. , in any year causes the price of food grains, vegetables etc. to be
harvested in coming season to go up as the crop will be destroyed or have very low

output.
Very high dependence on Monsoons (monsoon agriculture). Any change in pattern or
intensity of rains may change the output of the food crops, there is no sure shot way of
knowing if there will be enough harvest of particular vegetable, food grain etc. in a

year because it depends on rain which one cant predict fully.

High fluctuations in commodities prices such as Oil & Gas, Coal, Steel etc. which
indirectly affects the price of food items to the consumer. For example if price of
diesel used by trucks increases, it increases amount of currency a supply chain puts in

transporting the food item from farmland to consumers home.

Government too focussed on GDP than on tackling inflation, which sees inflation
necessary for high growth, forgetting if the inflation goes out of hand it can have

negative effect on the GDP.

Low level of R&D in agriculture, thus the output yield in not as compared to other

nations. With high input there is low output (supply).

Backward technology being used in agriculture, which prevents best use of the

resources available. There is an opportunity lost to produce more with less.

Transport bottlenecks, which is reason for loss of materials (stock) while transporting

food items from the farmers to the consumers (due to time taken).
Power shortage which doesnt allow for proper irrigation if present and processing of
food items before they are ready for dispatch by the farmers or the processors for

consumption by the consumer.

Poor agriculture/rural financing & credit system
Poor spending by the government & corruption
Continuous increase in expenditure by the government, which put more and more
money in hands of the public. Thus, the demand increases.

Indians prefer to save in banks than to invest, which causes the money to be locked

than being used to boost economy (turning of the wheel).

Increasing Fiscal Deficit (due to Deficit Financing)
Unable to tackle issue of black money efficiently (top to grass root level)
Purchasing Power of Rupee declines with inflation (depreciation of rupee against

dollar/ fluctuations hindrance in future & spot trading of essential commodities)

Number of middlemen between final consumer & the farmers, who take more of the
money for the food items than amount at which it was sold by the farmer. Thus,

increasing the prices of food items enormously.

Global increase in food prices ( increased 44% since 2007)

SOLUTIONS
Above we have briefly jotted down factors explaining inflation (food). Now, well be briefly
explaining what can be done/has been done to tackle the problem of inflation (food). They are
as following:

Starting a compulsory deposit scheme. So, that enough revenue is available for

government to borrow in time of emergency.

Increasing the CRR, which indirectly increase interest rates for the general public

(regulate liquidity & demand), thus there wouldnt be high demand.

Increase in taxes or add new taxes, to generate more revenue for the government or
discourage people from buying particular commodity or item which is giving rise to

food inflation (situational).

Having strong laws which prevents black marketing, hoarding and smuggling
Maintaining high levels of foreign reserves so, that country can import food items as

per the requirement when in need.

Having sufficient buffer stock (food grains, vegetables etc.)
Improvements in Public Distribution Systems
Fixing MSP, wholesale & retail prices so that farmers can get price for their yield and

be motivated to grow crops as required by the country.

Reduce/remove taxes (unnecessary) if situation permits to reduce price of food items

which are essential to public.

Regulate imports/exports as per the situation (economy)
Educate people on importance of population control (demand increasing

exponentially but the supply is not)

Administer prices (of essential commodities & public utilities)
Price control & regulation

Provide/invest in irrigation technology, R&D of fertilizers and seeds

Educate farmers about cross breeding of cattle, crop rotation, soil conservation & soil

reclamation
Provide farmers with affordable & easy loans to buy agricultural equipment such as

combine harvester, tractors etc.

Provide farmers with credit/finance for agriculture & animal rearing (milk & meat) at

motivating & sustainable rates

Introduce land reforms & see to it that they are effectively & efficiently put into
notion size, tenancy, rent etc. so that farmers can produce significant yield & can

earn enough income to keep them from leaving agriculture.

Provide weather, water levels and soil conditions forecasts to the farmers regularly
Invest in cold storages, warehouses & go downs so that buffer stock can be

maintained & food items can be stored till they are required for consumption.
Help farmers in marketing their products & keep them informed of the current market
rates (mandis/open markets) so that they can get appropriate prices for their goods
(food items).

Understanding the GST in an Indian Context

Basics about current tax structure in India:
Tax structure in India is divided between central government, state government and local
bodies. Income tax (tax on income of a person), central excise tax (tax on manufacturing of
dutiable goods), service tax (tax on provision of services) & customs duties (duties on import
& export of goods) are taken care by the central government. Value added tax (tax on sale of
goods inter & intra state), stamp duty (tax on transfer of immovable property), state excise
(tax on liquor & certain agricultural goods), land revenue & profession tax is taken care by
the state government. Tax on property, octroi & public utilities is taken care by local bodies
such as DDA, HUDA etc.
Taxes are divided into 2 kinds in India:
Direct Taxes, which falls directly on tax payer e.g. income tax, corporate sector tax, wealth
tax etc.
Indirect Taxes, which are levied on goods & services rather than on income or profits e.g.
central sales tax, value added tax, excise duty, customs duty & service tax.

Goods & Service Tax (GST):

The GST bill, officially known as the constitution (one hundred and twenty second
amendment) bill, 2014 proposes a national value added tax to be implemented in India from
April, 2016. GST would be comprehensive indirect tax on manufacturing, sale &
consumption of goods & services throughout India, to replace taxes levied by central & state
governments. The GST will dissolve all taxes into single tax which will make our country an
unified market. This would help, improve movement of goods across states n country &
reduce transaction costs associated with the production, supply & sale of goods & services. It
is a value added tax, thus each stage of production, sale or consumption will be set off against
tax paid previously.
Direct taxes such as income, corporate & capital gain tax will not be affected by the GST.
The proposed tax system will take form of dual GST, which will be concurrently levied by
central & state governments.
Central GST (Levied by the central government) will replace central excise duty, additional
excise duty, service tax, additional customs duty, special additional duty of customs, central
surcharges & cess, VAT/sales tax, entertainment tax, central sales tax, octroi & entry tax etc.
State GST (Levied by the state government) will replace purchase tax, luxury tax, tax on
lottery, tax on betting & gambling, state cess & surcharge etc.
Integrated GST (Levied by the central government on interstate supply of goods & services)
For interstate transactions, seller will collect CGST & SGST from the buyer. CGST will go to
centre & SGCT to the state.
For interstate transactions, integrated goods & service tax shall be levied on interstate
transactions of goods & services based on the final destination. Tax transferred to the
importing state.
Problem with current tax system is that it is unfairly against the producers. For example a bed
sheet manufacturer buys raw material (yarn) for Rs. 700, 00,000/-. He manages operating
profit at Rs. 200, 00, 000/- & has operating cost of Rs. 100, 00, 000/-. Thus, procurement of
raw materials at Rs. 700, 00, 000/- with 10% tax, operating cost at Rs. 100, 00, 000/- &
operating profit at Rs. 200, 00, 000/-. So, the selling price will be 700+70+100+200 = Rs.
1070, 00, 000/-.

By current taxation system the manufacturer has to pay 70 (on procurement or input taxes) +
107 (on sales or output taxes) = Rs. 177, 00, 000 as tax. However, if he follows GST he has to
pay Rs. 107, 00, 000/- as tax in total out of which he has already paid Rs 70, 00, 000/- earlier
(input tax), so he has to pay remaining Rs. 37, 00, 000/- to settle his taxes. Hence, reducing
the tax burden on him (producer).
Reducing such taxes would help in lowering overall production cost & improving efficiency
of the economy in the long run. GST will introduce uniform taxation laws across states, the
revenues from the taxes will be divided among state & centre based on terms agreed by both.
This will prevent any biasness towards any sector or state. Will improve supply &
distribution of goods & services, across India (by trying to solve the main issue of cascading
effect of taxes). In GST, the consumer pays the final tax but it is ensured there is no cascading
of taxes.
Workings of the GST:
a) Sale in a state, resale in same state (produced Kanpur then Lucknow then Varanasi
U.P):
Kanpur S.P = 1000 (SGST 10% = 100 & CGST 10% = 100) paid at Lucknow
Lucknow S.P = 2000 (SGST 10% = 200 100 & CGST 10% = 200 100) paid at
Varanasi
b) Sale in a state, resale in another state (produced Kanpur then Lucknow/U.P then
Gurgaon/Haryana):
Kanpur S.P = 1000 (SGST 10% = 100 & CGST 10% = 100) paid at Lucknow
Lucknow S.P = 2000 (IGST 20% = 400 SGST CGST = 200) paid at Gurgaon
c) Sale outside state, resale within the same state (produced Kanpur then
Gurgaon/Haryan then Faridabad/Haryana):
Kanpur S.P = 1000 (IGST 20% = 200) paid at Gurgaon
Gurgaon S.P = 2000 (SGST 10% = 200 IGST = 100 & CGST 10% = 200
IGST = 100) paid at Faridabad
Advantages of GST:

Reduction in production costs

Reduction in procedural costs
Step towards unified GST (currently towards dual GST)

Possibility on increase in revenues, as less chances of by passing (not paying taxes)

Distinction between goods & services will be removed

Disadvantages of GST:

States not sure of how revenue will turn out after the implementation of GST
Destination based tax not origin based (manufacturing states lose out)
List of items to be exempted from GST, is not decided/finalized
Can be reverted back to the current system by the next (opposition) government even

if passed this session

Taxes on services will increase substantially
Service sectors registration with each state may get hectic

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