Controlling high food inflation: The world is on a wing and a prayer

An IMF paper sheds light on the issue of persistently high global food inflation, and the prognosis is not comforting

The next general election is due in 15 months, in April-May 2024. So inflation is a major worry for the Modi government, and it won't want to take any chances.

Food inflation is of particular concern because it's the one thing that annoys the voter enough to vote out governments. The most important reason the Congress lost so badly in 2014, losing as many as 165 out of 209 seats, was the 65 per cent increase in food prices after 2011.

Currently, India's official number for food inflation is about 7 per cent. But in public perception, it is probably double that. That's why the government should worry. Voters believe what they experience, not what the data says.

In this context, it's helpful to see what will happen to food prices in 2023. A recent IMF paper sheds some light on this. It's not at all a comforting prognosis.

It is generally believed that food prices go up or down depending on the level of output. And that's true, of course. But the authors of the paper, Christian Bogmans, Andrea Pescatori, and Ervin Prifti, tell us that food prices depend highly on other factors too.

Their analysis shows that "a one per cent drop in global harvests raises food commodity prices by 8.5 per cent; a one percentage point increase in the Federal Reserve's main interest rate reduces food commodity prices by 13 per cent after one quarter; a one per cent increase in fertiliser prices raises food commodity prices by 0.45 per cent, and a one per cent increase in oil prices increases food commodity prices by 0.2 per cent."

Fertiliser prices are now double what they were before the pandemic. They were more than double till a few weeks ago. The paper says, "Around 45 per cent of any change in fertiliser prices usually feeds directly into global cereal prices within four quarters." That's pass-through for you.

To these certainties, the paper says we must add the uncertainties starting with "the Black Sea Grain Initiative that provides safe export shipping from Ukraine could cause another shock to cereal supplies if it is suspended again by Russia."

The authors say that "this alone would reduce global wheat and corn supplies by 1.5 percentage points, relative to current expectations, and in turn raise cereal prices by 10 per cent within a year."

If you think it can't get worse, it seems high energy prices will not just raise fertiliser prices; what's even worse, they will "divert output from food to biofuels."

To top it all, the La Nina conditions are returning. That means a colder Pacific Ocean, which means more erratic weather conditions.

But there is a silver lining, says the paper. "The Federal Reserve, for example, is raising borrowing costs at the fastest pace in two decades. Higher rates tend to discourage inventory holdings and reduce speculative activities in commodity futures markets, thus putting downward pressure on food prices."

The paper says that higher interest rates will continue to help lower food prices. But it needs to be clarified for whom. America alone?

Also, going by the "trading in futures markets… wholesale cereal prices will only drop 8 per cent next year from the current highs. But our estimates indicate supply constraints could outweigh weakening demand, keeping prices elevated for the next few quarters."

The paper makes two major recommendations to prevent persistently high food prices. One, the world should keep trade open, so local shortages don't develop. And two, all countries should raise domestic output. India is ok on the second count.

It doesn't say how these things are to be done. In that sense, the world is out on a wing and prayer.