Go with the grain

The credit policy announced by the Reserve Bank to curb price rise through a hike in interest rate follows a range of measures it had earlier taken to address inflation. The rise in the Cash Reserve Ratio and the earlier hikes in interest rates have yet to have their full impact on the economy. The contraction in demand due to higher borrowing costs should drive prices down over the next few months. Hopefully, we may soon see inflation levels decline and an end to interest rate increases.

In the wholesale price index based inflation rate, the sharpest increase has been in the prices of agricultural commodities. While the prices of manufactured goods have been rising between 5 and 6 per cent, those of food and non-food primary products have seen a rise of over 9 per cent. The answer to this sharp increase does not lie in bringing back controls or undertaking fiscal measures or changing tariffs when demand and supply conditions change. It also does not lie in allowing or prohibiting imports and exports. Such policies tend to turn farmer-friendly when prices are low and farmers have to be ensured a minimum return, and consumer-friendly when prices rise and consumers have to be quietened down. Such interference in the normal market functioning prevents the market from providing an effective signal to producers and consumers. The ideal policy is for the government to encourage the growth and development of well-functioning markets. If producers or consumers have to be given income support or subsidies, direct on-budget expenditures should be devoted to these objectives. Instead of undermining the market mechanism, the government needs to follow a policy of encouraging agricultural markets to function effectively. Removing barriers to the movement of agricultural products across state boundaries, allowing trade outside the mandi framework and dismantling expensive and archaic systems such as the FCI, have to be part of the agenda to develop a healthy agricultural market.

An important element in the functioning of markets that provides effective signals to producers as well as creates an opportunity for them to hedge their risks is the futures market for commodities. Instead of banning trading in futures markets, as has been done in the case of urad and tur, the market needs a better regulatory framework. Part of solving the agricultural question as well as achieving a low inflation framework is the development of well-functioning commodity derivatives markets.