H R Khan: Food inflation and agricultural supply chain management
Keynote address by Mr H R Khan, Deputy Governor of the Reserve Bank of India, at the
16th Conference of Globoil India, Mumbai, 22 September 2012.
* * *
The speaker acknowledges the contributions of Shri Ajay Prakash and Shri G V Nadhanael of the Reserve Bank
of India and the inputs from NABARD.
Shri Kailash Singh, Managing Director, Tefla's, Shri Ramesh Abhishek, Chairman, Forward
Market Commission, Dr. D. Bhalla, Joint Secretary, Department of Food and Public
Distribution, Government of India, Shri. Sushil Goenka and Vijay Datta of the Solvent
Extractors' Association of India, Shri. Sandeep Bajoria, Chairman, Globoil Organising
Committee, Shri. Dinesh Shahra, Dr. B. V. Mehta and other leaders from the edible oil and
agri-commodity trade industries, and distinguished delegates, both from India and abroad. It
is indeed a pleasure to interact with people from the agribusiness world, especially at a time
when the demand for food items are rising and is expected to continue to rise for several
years from now. I am sure people here who have greater exposure and expertise can
elucidate in much better way the ground level facts about the current rise in food prices,
particularly that of edible oil and challenges that lie ahead in countries like India which are
net importers of edible oil. I thank both Globoil India and Tefla's for inviting me. I wish to
congratulate Globoil India on its 16th Anniversary - a long enough period for an organisation
to grow out from infancy and reach adulthood. Around 50 per cent of India's domestic
consumption of edible oil is met through imports and India has an import share of more than
15 per cent in the world market. Given this, Globoil has an important role to play and I wish
them all the best in their efforts. I hope the proceedings of this event would help in improving
domestic productivity, availability and marketing efficiency of edible oils.
Taking a broader and generalised view of your industry, I shall be looking at the role of
agribusiness in growth of the economy as well as inflation management. In particular, I would
be discussing the importance and potential of supply chain management in the evolving
scenario.
Growth and inflation - role of agribusiness
Before discussing the role of agribusiness in growth and inflation, it would be apposite to
define and understand the concept of agribusiness. Way back in 1957, Davis and Goldberg1
had defined agribusiness very lucidly as the sum total of all operations involved in the
manufacture and distribution of farm supplies; production operations on the farm; and the
storage, processing and distribution of farm commodities and items made from them. Thus,
agribusiness essentially encompasses today, the functions which the term agriculture
denoted 150 years ago and agriculture now is a subset of the larger superset called
agribusiness.
As far as growth and inflation is concerned, you may be aware that the weights attached to
objective of growth vis-à-vis that of price stability in choice of policy measures vary according
to the extant macroeconomic environment. For example, during the Great Moderation, the
policies all over the world were focussed on growth enhancing measures. Presently, in view
of the continuance of low inflation and low or negative growth in the developed economies,
the policy measures, mainly in the form of liquidity enhancement and low interest rates,
continue to focus on augmentation of growth.
In India, however, the conditions are very different. Along with economic slowdown, inflation
is ruling significantly above the threshold level, beyond which inflation turns inimical to
growth. Under the current macroeconomic environment, Indian policy makers have to think of
various measures that can simultaneously achieve the twin objectives of higher growth and
lower inflation. Opinions differ on the utility of different policy measures at the current
juncture and you all may be familiar with the current debate on the timing, sequencing and
complementarity of various measures. There is, however, near unanimity, amongst all that
agriculture and agribusiness growth is a necessary prerequisite for moderation of inflation,
particularly food inflation, as well as for acceleration and sustenance of inclusive growth.
The impact of agribusiness on inflation is also both direct and indirect. The direct impact of
agribusiness is visible in the form of food inflation. With demand arising from increasing
population and prosperity outstripping the growth of agricultural output, food inflation is likely
to persist at the global level for the next several years. OECD-FAO has predicted that a grim
global food inflation outlook could continue in the next ten years. The OECD-FAO
Agricultural Outlook 2011-20 indicates that food prices may be higher in real terms over the
five years 2015-20. For example, prices of oil seeds are projected to be higher by
36 per cent relative to the levels prevailed during the five year period 1998-2003.2 High
prices at global level limit the use of imports as a tool for our domestic inflation management.
Even when global prices are low, the import option is limited as mere news of entry of a large
consumer like India entering the global market can spike up prices. Further, higher imports
would only add to the pressure on our already high current account deficit.
The indirect impact of agribusiness on inflation is reflected in the rise in cost of living arising
from high food inflation leading to higher wages, which, in turn, contributes to generalised
inflation through higher cost of production. This may trigger a wage-price spiral. Hence,
though food inflation or at least spike in food inflation is normally a supply side phenomenon,
it is monitored very closely and remains one of the most difficult challenges for the central
banks. The Reserve Bank is presently grappling with this challenge of high food inflation as
often monetary policy has to act as the first line of defence, even if it is a persistent supply
side issue. However, managing food inflation from a medium-term perspective would include
measures to increase production, improve productivity and enhance efficiency of supply
chain management.
On the growth front, while service sector has been driving growth for the past several years,
acceleration of growth of the economy and its sustenance at higher level critically hinges on
the performance of agriculture sector in terms of supply of food and food products,
employment of large section of population and providing a large and growing demand base
for the other segments of the economy, viz., industry and services. Given the strong
backward and forward linkages of agribusiness with both the industrial and services sector,
this sector not only directly contributes to growth but also facilitates growth in the rest of the
economy. Also, the growth of agribusiness has the potential to generate gainful employment
within the farm sector, which could help in reducing the incidence of underemployment and
disguised unemployment in agriculture.
The role of agribusiness has become even more important in the context of the challenges
that global economy faces in enhancing food production to cater to increasing demand for
food, fuel and feed. OECD-FAO estimates3 suggest that with world population touching
9 billion by 2050, agricultural production will need to increase by 60 per cent over the next
40 years to meet the rising demand for food. Additional one billion tonnes of cereals and
200 million tonnes of meat a year has to be produced by the year 2050 as compared with
2005-07 levels. The demand for bio-fuel production is also expected to double. Increased
demand for meat and meat products also require additional agricultural feedstocks. Given
the limited scope for expanding farmland area around the world and problems of soil
degradation and water scarcity, apart from over exploitation of fish stocks, augmenting
agricultural production has become a major challenge. Global warming, climate change and
extreme weather conditions have added further uncertainties.
Increases in food prices across the globe have become a major issue in recent years. The
spike in global food prices that was witnessed during the period 2004-08 had significant
welfare consequences in terms of millions of people pushed into poverty and hunger. The
increase in prices was witnessed in almost all the major commodities and edible oils have
been no exception. Though prices have been volatile in recent period, the forecasts suggest
that the prices could continue a secular upward trend, which could put pressure on inflation
This is a critical issue for a country like India which is a major importer of edible
(Chart 1).
oils. Also, it has been observed that in India, the domestic prices are significantly impacted
by the trends in global prices of edible oils.
Incidentally, during the current year so far, inflation at the retail level in oils and fats has been
higher than at the wholesale level (Chart 2). While this phenomenon can be attributed to a
number of factors, improvement in supply change management will certainly help in
narrowing the gap. Also, the price trends at retail level indicate that the price paid by final
consumer for the edible oil differs significantly across major cities within the country
While some part of this divergence could be attributed to factors like transportation
(Chart 3).
cost and state specific taxes as well as quality of product, the difference of such magnitude
also point towards issues related to supply chain which is critical in a country like India which
has a large domestic market.
Hence, I shall now turn to the supply chain through which farm products move to reach the
final consumers and need to be upgraded in view of the growing challenges mentioned
earlier.
Supply chain management and agribusiness
It has been observed that there is a wide divergence between the farm gate prices and retail
prices of various food items. The usual reference to 1-2-3-4 in supply chain is quite well
known, where what the producer sells for one rupee, by the time it reaches the final
consumer fetches four rupees due to the presence of intermediaries. The recently appointed
Inter-Ministerial Group4 on Inflation has emphasised on the need to cut down the margin
between farm gate prices and retail price. Improving supply chain is beneficial both for the
producer and final consumer as producers would get remunerative price for his produce and
consumer would be benefitted from the lower price. Therefore, increasing efficiency of supply
chain could help in bringing food inflation down and increase the efficiency of our food
markets and make our agriculture sector sustainable and viable.
A well-known feature of current structure of food inflation is the sharp rise in prices of protein
food items. These comprise perishable items such as milk, eggs, meat, fish, vegetables and
fruits - all of which require advanced and effective supply chain management.
Different aspects of agribusiness and the supply chain are undergoing transformation which
is likely to continue in future. Emphasis on processing, trading and marketing is going to
increase over time. Demand for protein rich and other high value food like fruits, vegetables,
edible oil and livestock products are increasing. Demand for high quality, safe and
convenient (frozen, pre-cut, pre-cooked and ready-to-eat) foods is rising. Meeting these
demands emanating from within the country and from the growing Indian diaspora through
more efficient supply chain management is expected to facilitate growth and moderate
inflation.
Supply chain management and agricultural business are integral part of agricultural
marketing system. Efficient supply chain and business models are necessary for creating
efficient agricultural market which delivers agricultural produce from the farmer to the
consumer in the most efficient way. While output and productivity are supply side factors,
markets provide an intermediate link between producers and final demand by consumers.
Efficiently functioning markets add to welfare of producers as well as consumers. Efficient
agricultural markets can also be a potent tool for poverty reduction.
Agricultural markets in India, in particular the supply chain management and business
models, are inefficient. In India, farmers' produce is generally disposed of in the village,
rural/primary market or secondary agricultural market. The challenges facing supply-chain
management and agribusiness in India can be broadly classified into three, namely, 1) lack
of accessibility to regulated markets, 2) lack of competitition under the Agricultural Produce
Market Committee (APMC) Act, and 3) absence of a nationwide common agriculture market.
These are challenges that run across the various channels through which the supply-chain
and agribusiness models operate. These channels are (i) Producer-Consumer,
(ii) Producer-Retailer-Consumer, (iii) Producer-Wholesaler-Retailer-Consumer,
(iv) Producer-Commission agent-Wholesaler-Retailer-Consumer and (v) Producer-Village
Merchant-Wholesaler-Retailer-Consumer.
Agriculture markets in India are regulated through the model APMC Acts. The number of
regulated (secondary) agricultural markets stood at 7,157 as of March 2010 as compared to
just 286 in 1950. There are also about 22,221 rural periodical markets, about 15 per cent of
which function under the ambit of APMC regulation.5 The model APMC Act allows States to
collect market fees from the buyers/traders on the sale of notified agricultural produce which
are generally high. The high incidence of commission charges on agricultural/horticultural
produce renders marketing cost high. There are other charges like entry tax/octroi tax that
vary across states as well as across commodities. These charges prevent the emergence of
a nationwide common market for agricultural produce. Moreover, restrictions on the
movement of goods under the Essential Commodities Act remain in place in various states.
These had inhibited free access of agriculture markets. Most of the agricultural markets are
also characterised by dominance of cash based transactions where issues of cash
management also become important. Also, there are issues of weights and measurements
as well as the presence of brokers and commission agents.
There is reason to believe that regulatory barriers have constrained investments in
development of storage and processing facilities, hampered the development of effective
institutions, and lowered the capacity of agricultural producers to be internationally
competitive. India, for example, is the world's largest producer of fruit and vegetables but it
has been estimated that inadequate post-harvest storage and transportation cause losses of
around 30-40 per cent, only 7 per cent value addition takes place, and only about 2 per cent
of production is processed commercially. Road connectivity, development of horticulture,
dairying & other animal husbandry activities and expansion of cash crops, which provide the
necessary wherewithal for greater access of the farm sector to market oriented agriculture
are still lacking in the country. This is particularly important for the segment of "high value"
agriculture, where demand pressures are going to be most intense in the coming years, and
major investments will be needed in the development of efficient value chains to save on
high wastages and intermediation costs. The inadequate facilities for storage of products
also results in considerable seasonal fluctuations in the prices of products.
The country needs a single point market fee system for facilitating free movement of
produce, bringing price stabilization, and reducing price differences between the producer
and consumer market segments. Use of Information & Communications Technology (ICT)
solutions (for example, pre-paid card based payments at octroi posts) would facilitate easy
movement of agricultural produce. Besides boosting productivity on a sustained basis,
cleaning, grading and packaging of agricultural produce, would have to be popularized for
greater market penetration. The current fragmented marketing system and lack of
infrastructure are the serious constraints to the efficient functioning and competitiveness of
supply chains in India. An efficient supply chain would need to integrate the supply chain with
the value chain wherein at each stage within the chain, significant value addition takes place.
It is essential to link the farmers with the markets with state-of-art infrastructure. Effective
linkage can help remove the constraints of logistics, quality maintenance and thus, help in
efficient access, delivery, price discovery and compete with global products. Linking small
primary producers with markets can help improve the livelihoods for millions of poor in India.
Banking and bank finance also plays a critical role in the entire agribusiness chain.
As a result a broad consensus has emerged about the need for reforms in agricultural market
policies and important reform measures have been implemented in recent years, as part of
the ongoing policy reform process in India, such as, amendments to the APMC Act as also
the recent initiative to allow Foreign Direct Investment (FDI) in the retail sector. At a more
specific level, introduction of negotiable warehouse receipt system, the scheme of bank
financing against such receipts, establishment of Warehouse Development & Regulatory
Authority (WDRA) and guarantee support scheme up to ten years for construction of
warehouses/storage facilities would provide much needed fillip to efficient marketing
management and price risk reduction for the producers. Further, the disbursements under
the Rural Infrastructure Development Fund (RIDF) administered by the National Bank for
Agriculture and Rural Development (NABARD) with a special earmarking of ₹50 billion for the
year 2012-13 for developing cold storage and warehousing facilities in rural areas would
also provide boost to infrastructure development for marketing efficiency. External
Commercial Borrowing (ECB) for infrastructure to cover cold storages has also been allowed.
Considering the need to boost the supply and value chains in certain critical agricultural
products that have significant implications for both the producers and the consumers,
NABARD has initiated a few pilot programmes on supply chain development for potato in
West Bengal and Uttar Pradesh, onion in Maharashtra and tomato in Punjab and Haryana.
These projects, which would involve the banks, the State Governments and the research
institutes, are comprehensive in nature and are expected to help the farmers in better
sorting/packaging, warehousing and marketing apart from helping at the production stage by
adopting better agricultural practices, involving quality inputs and R&D support.
Measures to improve supply chain
The suggestions from various policy documents to strengthen the supply chain can be
classified into: 1) enhancing the capabilities of farmers, 2) strengthening infrastructure, and
3) legislative interventions. By encouraging farmers to organise themselves into groups
- growers' groups, co-operatives, self-help groups, joint liability groups, and producer
companies given the preponderance of small and marginal farmers in our country - supply
chains can be streamlined as well as made more egalitarian. Recently, NABARD has set up
Producers Organization Development Fund (PODF), which could play a catalytic role in this
regard. Also, investments across the entire agro-value chain spectrum, such as creation of
cold chains, rural godowns, new agricultural marketing infrastructure, and modernisation of
existing markets could be promoted by providing them fiscal incentives. As suggested by the
Inter-Ministerial Group on Inflation, perishables could be taken out of the ambit of the APMC
Act to encourage arbitrage activity by small traders and farmers by allowing them to freely
trade perishables through buying where it is cheap and selling where it is expensive.
Similarly from the long-term perspective of inflation management, it is crucial to improve
mandi governance with focus on transparency and efficiency by holding regular elections of
agricultural produce market committees as well as to bring professionalism into the
functioning of the existing regulated markets through public private partnership.
Analysis of international market developments reveals that encouraging large scale
integrated players to develop the supply chains in various commodities with latest technology
infrastructure is the right approach suitable for Indian conditions. The existing system of
fragmented handling of various supply chains should be converted into integrated handling
systems so as to ensure better realisation to the farmers. Contract farming and supermarket
procurement arrangements are two supply chain arrangements that are gaining ground amid
active debate in India. Recent experience in India indicates that contract farming and
supermarket procurement approaches will have to involve small-scale farmers in the medium
term, because the farm structure obliges them to do so. Initiatives like the one in Argentina
by the company El Tejar where the small and marginal farmers are pooled together by taking
the land on rent and providing them wage employment could be experimented. In some
countries, public-private partnerships have been instrumental to the success of new supply
chain arrangements, for example, in providing extension and technical assistance to improve
the quality and safety of produce and accreditation of farmers. The country needs a
convergence platform at national, state and district level where private players join hands
with large number of farmers through various ongoing schemes and programmes of Central
and State Governments in a PPP mode. Approaches to promote equitable participation by
large-and small-scale farmers who constitute more than 80 per cent of the rural farming
community would include:
•
Facilitating entry and competition among buyers, for example, improving the rural
infrastructure or establishing collection centers to reduce the transaction costs
involved in sourcing from small scale farmers;
•
Organizing farmers into formal or informal groups to meet the volume requirements
and strengthen farmers' bargaining power;
•
Reforms in tenancy laws and legalizing tenancy farming to facilitate establishment of
production rights and credit flow;
•
Enhancing farmers' capacity to adopt improved production and post-harvest
techniques to meet the required higher quality standards;
•
Assisting farmers to obtain the capital, in addition to short-term production loans
given by banks, to make on-farm improvements and other required investments, for
example, micro-irrigation, greenhouse, grading, or cooling facilities and acquire
essential national and international certifications;
• Efficient dissemination of market information to the producers by leveraging ICT (for
example, mobile phone based market information propagation);
• Training farmers and buyers about their rights and obligations under contract
farming arrangement and in the design of contracts; and
•
Developing institutions that assist farmers to settle contract disputes, such as,
commodity or market associations.
•
The Working Group of the 12th Five Year Plan on "Agriculture Marketing
Infrastructure, Secondary Agriculture and Policy Required for Internal and External
Trade"6 has identified the following models of agriculture marketing that should be
emphasized during the Plan period viz., a) greater responsibility to producer
organizations; b) direct linkage with retailers/processors/exporters; c) price
discovery through virtual market platform; d) direct marketing; e) organized retailing
and removing restrictions on FDI for greater competition; f) market access for small
producers; g) reforms in APMC Act; h) integrated value chain system covering even
areas like partnership, information and communication technologies, leveraging
networks, value chain financing, smallholder policy, and contracts; i) promotion of
innovative marketing models for effective market participation, and j) PPP for
efficiency and effectiveness.
Finally, in the context of the role of public distribution system in cereals also needs to
undergo a transformation. There are two opposing views on the desirable strategy of the
PDS system. According to some, PDS should play a stabilising role by releasing stocks when
food prices are high, particularly during periods characterised by supply chain manipulation.
However, there are others who opine that the PDS dilutes competitive market forces and the
government instead should focus on removal of supply chain rigidities. Given this rise in
demand due to urbanisation and migration, higher per capita incomes, changing dietary
habits, on one hand, and the huge costs and leakages associated with PDS, on the other, it
is considered desirable and imperative for competitive market forces to play an increasingly
greater role over time. The proposed alternatives to PDS like cash transfers/food coupons
would also be effective only with the presence of a well integrated supply chain. Otherwise,
the supply chain manipulation could lead to exploitation of cash transfer beneficiaries and
could have implications for food inflation.
Concluding remarks
I would like to conclude by saying that the world is destined to struggle with shortage of
supply of agricultural commodities vis-à-vis the growing demand for several years. The
pressure would be reflected, among others, in rising prices. Apart from raising agricultural
productivity, improvement in management of supply chain would be critical for sustenance of
overall economic growth and for prevention of runaway rise in prices. Diversification into
non-traditional areas like biofuels, polymers, pharmaceutical/health products and feed for
poultry and diary to meet growing demand for protein food has major implications for supply
chain. Increase in complexity and decentralisation of agribusiness organizations would guide
the future changes in supply chains. It would also entail the need for development of new
concepts and techniques. I hope you all would deliberate on these issues and suggest the
way ahead.
I thank Tefla's and Globoil once again for giving me this opportunity to share some of my
thoughts with such distinguished participants.