One would wish not but the signals on the food price front in India are not at all encouraging. The symptoms of the underlying problems on the food price front are well captured by the soaring prices of staple foodgrains such as rice and pulses in the open market. The price rise in some of these categories seems capable of providing a shock even to households in the middle income / upper middle income segments. It is not difficult to imagine how adverse the impact will be for households in the lower income segments.

Broadly, there is a serious supply constraint in key agricultural products such as pulses, oilseeds / edible oils and in some cases even in the staple foodgrain, rice. These constraints have developed over many years. Overall macro economic policy, though, has not been addressing this structural supply constraint. On the contrary, more demand pressure has been generated over the years through lax and poorly directed fiscal and monetary policies. Expanded fiscal programmes, while absolutely necessary in key social sectors such as health or education, have unfortunately become expansionary and too revenue expenditure focused over the years. The result is burgeoning demand which is outstripping supply across many product segments. In the circumstances, a further rise in key food prices such as pulses or edible oils seems quite well possible.

Structural problems in agriculture

The problems in agriculture are well-known. Productivity in the rural sector has been stagnant or even decelerating on a long-term basis. The key causative factor behind that fall is the conspicuous absence (or at best, marginal rise) of productivity enhancing investments in agriculture. Investments and capital formation in agriculture have broadly accounted for less than 5 per cent of the total capital formation taking place in the Indian economy over the past many years. That is, while capital formation in the industrial or services sector - say in the form of critical or hi-tech machinery, factories and commercial buildings / construction - has been taking place at a robust pace, capital assets creation in the agricultural sector - say a minor irrigation project, cost saving implements or even a warehouse - has been slow in coming.

Output patterns are determined by the investment patterns. It is not surprising, in this backdrop, that agricultural GDP growth (output growth) has averaged only around 2.5-3 per cent over the past many decades even as the average growth in the industry / services sectors has improved significantly from its levels in earlier decades (around 4-5 per cent) and is now running close to 8 per cent.

As can be noted from the table, rice output has registered a CAGR of less than 2 per cent between 1990-91 and 2007-08. Output growth in wheat is marginally better at just around 2 per cent. Pulses have been a major drag with output essentially remaining unchanged in all the years between 1990 and 2007. The record in oilseeds is also nothing much to speak of. While we may have avoided large scale and regular imports of rice and wheat (despite this low rate of growth), India is the largest importer of edible oils and pulses in the global markets. Not surprising given the dismal output performance in these key products.

It is not difficult to understand the sharp rise in food prices when we set this meager growth in the output of key food crops against the substantially higher rise in nominal incomes in the economy. Nominal GDP in the overall Indian economy has grown at something like 15 - 16 per cent over the past many years. It is inevitable that the huge difference between the nominal GDP growth rate of 15 per cent and the agricultural output growth rate of around 2.5 per cent is reflected in the price levels. That is, the difference between the low real growth (output growth) and the high nominal income growth has to be filled in only by high (and rising) price levels. Therefore, the micro economics of the market in pulses or edible oils, marked by sharp price rises, is quite well explained by the broader macro forces which increase demand while at the same time do not do much to relieve the constraints in supply.

Misdirected expenditure compounds problem

The problem on the food prices front is a function not only of the meagre investment flows into the agricultural sector and the consequent weakness in capital assets creation / productivity as shown by the data above. Compounding the structural constraints in agriculture is the sharp rise in revenue expenditures of the government. As the accompanying chart shows, revenue expenditure - whose share in total expenditure even at the turn of the 1990s was quite high at around 75 per cent, has increased further sharply in the last 2 decades and now accounts for as much as 90 per cent of all government expenditure. Capital expenditure consequently has fallen - from 25 per cent at the turn of the 1990s to just 10 per cent of total expenditure.

Quite simply, what this significant revenue expenditure expansion has done over the years is to hand out large amounts of money for people to spend. One has to also note that this fiscal activism has been matched by expansionary monetary policies in India over the past many years.

It is well-known from the historical experience of even the advanced western economies that policies - fiscal and monetary - that simply give people more money to spend, are likely to find their way into higher prices for a range of goods and services and even real assets such as property. This experience is even more valid and critical for India given the inherent supply constraints operating here.

One may be wondering how non-agricultural sector investment has risen so significantly (see table above) despite the notable fall in the overall capital expenditures of the government over the last two decades. That is explained by the fact that non-agricultural sector investment is driven predominantly by the private sector. The private sector - both households and the corporate sector - have significantly better access to both domestic household savings as well as external savings in the form of risk capital / borrowings.

The agricultural sector, on the contrary, primarily depends on state intervention, funding and expenditures to spur investments and capital formation. If India continues to run large budget deficits, those deficits would be well spent if a much greater proportion of expenditure were to be directed to the agriculture sector.