Subir Gokarn: The price of protein
Inaugural address by Dr Subir Gokarn, Deputy Governor of the Reserve Bank of India, at a
special conference in honour of Dr Kirit Parikh at the Indira Gandhi Institute of Development
Research (IGIDR), Mumbai, 26 October 2010.
* * *
Assistance provided by Balbir Kaur, Praggya Das, Abhiman Das, Nishita Raje, Muneesh Kapur, Rekha Misra and
Deepa Raj is gratefully acknowledged. This address draws upon the ongoing research project in the Reserve
Bank on structural drivers of food inflation in India.
Introduction
It is a great pleasure for me to be speaking at this seminar to celebrate the 75th birthday of
Prof. Kirit Parikh. During the time that I spent at IGIDR under his leadership, I had the
opportunity to work on a number of issues, on all of which I received enormous support and
encouragement from him, which has continued even after first I and then he moved on to
other institutions. My years at IGIDR provided me firm foundations in individual and collective
research as well as teaching and dissemination, which have served me very well in the
activities I have been involved in since then. I would like to thank him for his role as a mentor
and belatedly wish him a happy 75th birthday. I am glad that in my current position I can
contribute to shaping IGIDR's strategies for the future.
If I was asked to describe Prof. Parikh's approach to research in one sentence, it would be:
"Focus on the details, never losing sight of the big picture". The balance between micro and
macro, between individual drivers and aggregate outcomes, was visible in a lot of the
research that was carried out at the institute during my time here and it is an approach that I
have found most useful in applied research. Since I joined the Reserve Bank, several
colleagues and I have been trying to understand the dynamics of food prices, which have
been a major driver of domestic inflation over the past few years. I thought that this seminar
would be an entirely appropriate occasion to present some of our analysis of the micro-level
price dynamics of specific food items, based on demand-supply fundamentals and then
relate this analysis to two very significant "big picture" issues.
The context
When we break down recent food inflation into contributions by different items, a striking
feature is the role played by key sources of protein. The dominant source of protein in Indian
diets is pulses, which of course vary quite significantly across regions and, to some extent,
between income groups. Milk and milk products also figure quite prominently and then we
have Eggs, Meat and Fish. Analysis of dietary patterns in terms of income elasticities
suggest that as incomes increase, the share of proteins in representative diets also
increases. In other words, as levels of affluence increase, the demand for proteins is bound
to increase overall; the form in which they are consumed will, of course, differ based on
geography and socio-cultural factors. In recent years, the shifts in the income distribution and
their impact on the demand for a whole range of products - two-wheelers, automobiles,
consumer durables, mobile phones and so on - has been extensively analyzed, which in turn
has provided significant inputs into business strategy. When it comes to proteins, apart from
business strategy, the impact of income growth and distribution has significant policy
implications as well, which is what I mean by "big picture" issues and which I shall come to
later in the presentation.
Price dynamics
The recent transition in the Wholesale Price Index from the 1993-94 base to the 2004-05
base highlighted the impact that a changed production/consumption basket can have on
measured inflation. Specifically, food inflation as measured by the new index is noticeably
higher than that measured by the old one. The primary reason for this is that the items that I
have been talking about - alternative protein sources - along with some others, have higher
weights in the new index, which, of course, suggests that the price of proteins has been
increasing relatively faster than other food items. Slides 1 and 2 display the relative rates of
increase.
From Slide 1, it appears that the price levels of Pulses began accelerating in 2005 and have
continued to do so since then. There is a sustained divergence between the Pulses index
and the overall Food index, which suggests a structural change in relative prices. Of course,
there is a wide variety of pulses consumed across the country, with strong regional patterns.
But, even at an aggregate level, Pulses are clearly becoming more and more expensive and,
contrary to widespread perceptions, this does not appear to have much to do with the
performance of the monsoons. Milk and Eggs, Meat and Fish also show a distinct upturn in
price levels, though this is of somewhat more recent origin than for Pulses.
Slide 1
Prices of proteins
Slide 2 displays the inflation rates for these three sets of food items. The pattern for Pulses
appears to conform to perceptions about sensitivity to monsoons. At least in the most recent
months, the inflation rate for pulses has dropped significantly - in fact, below the overall rate
of food inflation. However, the inflation rates for the other two items continue to be above the
overall food inflation rate. The rate for Eggs, Meat and Fish has dropped a bit, but the rate for
Milk appears to have its own dynamic.
Slide 2
Inflation rates of proteins
Of course, this is not sufficient to draw any inferences about the structural nature of protein
price inflation. Slide 3 presents the results of the decomposition of the three price level
series. The red lines capture the structural components and the picture is unmistakable; the
prices of all three protein sources are on a strong upward trajectory, which, is occasionally
offset by favourable cyclical factors, particularly in the case of Pulses, given the direct impact
of monsoon performance on Pulse production.
Slide 3
Structural components
Demand drivers
The 61st Round (2004-05) of the National Sample Survey is the most recent large sample
data available for consumer expenditure. Though dated, it provides a basis for analyzing the
relationship between household affluence and expenditure on various items. In the course of
this project, we have estimated price and income elasticities for a variety of food products,
including the three categories on which this presentation is focused, at several levels of
disaggregation - by item, by state and by income fractile. The results will eventually be
published in a detailed report, but given the occasion and time constraints, I would just like to
convey a sense of what we are attempting to do. Essentially, it is the analysis of inflection
points: what is the threshold level of income (or, in this case, household expenditure) at
which the composition of the diet changes significantly. A national aggregate is not a very
precise way of doing this, given the enormous variations in factors that drive consumer
behavior across the country, but it serves to illustrate the approach.
Slide 4 presents the relationship between Monthly Per Capita Expenditure (MPCE), which is
of course a proxy for household affluence and the level of spending on the three protein
sources that we are discussing. Interestingly, the expenditure on Milk and Milk Products is
higher than that on Pulses in all expenditure fractiles of the urban population, while it begins
to dominate Pulses at a fairly low fractile in the rural population. Eggs, Meat and Fish also
begin to dominate Pulses, though at somewhat higher income fractiles in both rural and
urban populations.
Slide 4
Consumption of proteins
Source: Level and Pattern of Consumer Expenditure 2004-05, NSS Report No.508.
But, to focus on the main point that this analysis seeks to make, it is the points of inflection
visible on the graphs that are most relevant. I would like to present a simple simulation
exercise to illustrate the use of this information for making aggregate projections of demand
for these items. Slide 5 presents a summary of the exercise. Let us assume that the point of
inflection on the graph reflects the expenditure level (in 2004-05 prices) at which diets shift
decisively towards higher consumption of proteins. Between 2004-05 and 2009-10, per
capita incomes grew by about 39 per cent. With this growth, how many people are likely to
have reached this threshold by 2010? Assuming that the distribution itself remains constant,
the simulation reveals that about 220 million - 180 million in rural areas and 40 million in
urban areas - people would have reached the threshold level of MPCE over this five-year
period. In addition to this, people who were already above the threshold in 2004-05 would,
as a result of rising incomes, presumably also increase their consumption of these items.
Slide 5
A simulation exercise
At the aggregate level, this analysis presents a dramatic picture of how increasing affluence
is impacting the spending on protein sources. This pattern is in complete conformity with
global historical precedents, a point to which I shall return in the discussion of "big picture"
issues. This is exactly the kind of dynamic that has been seen in the Indian economy for
products like two-wheelers, automobiles, various consumer durables and a host of others.
But, unlike in food items, the massive expansion of demand for these products was not
accompanied by a sharp surge in prices. The obvious reason for this was that the supply
response in these markets was strong enough to keep pace with demand. A combination of
large new capacities, free trade and scale economies and technological progress has helped
to increase supply even while costs have fallen. Unfortunately, the same powerful supply
response is yet to manifest itself as far as proteins are concerned.
Supply conditions
Let us take a brief look at the supply scenario in each of these protein sources. Slide 6
displays the per capita availability of Pulses as a whole and separately for Tur (Arhar). This is
a story of long-term decline in availability, in which production has not been able to keep
pace with population growth, let alone increasing affluence and, consequently, greater
demand for both Pulses as a whole and Tur in particular. Heavy rain dependence, small
holdings and weak rural infrastructure seem to be preventing any break-through surges in
productivity in the way that massive increases in cereal production was achieved. Slide 7
shows just how volatile the supply situation in Pulses is. As regards production and yield,
there is a reassuring trend towards stable growth during the past couple of years at the
aggregate level. However, the disaggregated picture shows that individual Pulses are subject
to relatively high production volatility, which given the relatively low degree of substitutability
that is visible in Pulse consumption, inevitably contributes to price volatility. Overall, if the
very recent trend in aggregate production is sustained, supply constraints will ease. Going by
the past record, however, there do not appear to have been persistent phases of output
growth, which indicates the difficulty of achieving a break-through.
Slide 6
Stagnation in pulses
Source: Ministry of Agriculture.
Slide 7
Production, yields and growth
One option is to import Pulses. Since very few other countries produce and consume
significant quantities of this item (and certainly, Tur is virtually unique to India), this would
have to be in the form of contract farming arrangements. While this may be feasible in terms
of actual production, transportation costs are likely to neutralize any benefits from such
arrangements as a way of meeting demand while keeping prices in check.
Slide 8 displays the supply scenario for Milk. In terms of per capita availability, it is clearly a
far more reassuring trend than for Pulses. This indicator of supply has been rising steadily,
reflecting the many organizational and logistic innovations that were effectively implemented
in this sector. However, two factors need to be taken into consideration here. One, the
second graph on the slide indicates that the growth rate of Milk production is declining and
volatile. Two, returning to the demand perspective, Milk is the most significant source of
protein in expenditure terms for most households. Since it is directly related to the age
composition of households, the preponderance of growing children and young adults is likely
to boost demand for milk, all other factors remaining equal. With a sustained increase in
demand, slowing growth and volatile production will clearly have an impact on prices.
Slide 8
Milk production and per capita availability
Source: Department of Animal Husbandry, Dairying & Fisheries, Ministry of Agriculture, Government of India.
Slide 9 provides one explanation for why the Milk supply situation may be turning adverse.
Oil cake is a significant component of cattle feed and its price clearly has an impact on the
cost of production of Milk. With oil cake prices trending up quite significantly over the past
few years, changes in the feed mix may be resulting in lower yields, contributing to
supplydemand imbalances and price pressures.
Slide 9
Rising input costs
The picture for Eggs, Meat and Fish is generally similar to that of Milk. For illustrative
purposes, Slide 10 displays the per capita availability and growth rates for Egg production.
While production and availability have been increasing, the growth rate shows relatively high
volatility, raising the prospect of price surges in the face of steadily increasing demand. Of
course, given the significance of the informal sector in the production and distribution of all
these items, production data might reasonably be considered a bit suspect. However, the
bottom line is that the price dynamics of this category of proteins are entirely consistent with
an emerging structural imbalance between demand and supply.
Slide 10
Production and per capita availability of eggs
Source: Annual Report, 2008-09 of the Department of Animal Husbandry, Government of India.
Big picture issues
So far, I have been dealing with the microeconomics of protein prices - the interplay between
demand and supply for individual food items. I will conclude this presentation by exploring
the linkages between the micro and the macro with reference to two important issues.
The first is the significance of these individual price dynamics to a basic concern of central
banking. From a monetary policy perspective, the conventional view of food prices, is that
surges are temporary, driven by supply disruptions that at worst last one season. As
conditions return to normal, as they usually do, the price surges are expected to recede.
Transmission lags in monetary policy are generally seen to be longer than the typical
agricultural season, so, if monetary instruments are used to deal with such price shocks, they
have no impact on the immediate cause of the problem, while possibly doing damage to
growth prospects down the road. However, if the economy is at or close to full capacity
utilization, even a temporary price shock can aggravate inflationary expectations, which may
justify a monetary response even though the shock is temporary and will die out before the
actions take effect. But, when we begin to consider the impact of structural food price
shocks, such as the ones we appear to be experiencing in the Indian context, the policy
implications become complex.
Do we treat these developments as a change in relative prices, with consumers substituting
away from the increasingly expensive food items, with no particular macroeconomic
significance and, therefore, no implications for policy? Or, do we see them as a threat to
overall price stability because there are really no substitutes for protein and increasing prices
of its sources will immediately translate into higher wages and, through them, to generalized
inflationary pressures, which certainly warrant a policy response? Persistent price increases
in commodities for which there are no effective substitutes will, other things remaining equal,
raise the potential rate of inflation over a period of time. This means that either actual
inflation or interest rates will be higher than they would be in the absence of such increases.
The second big picture issue relates to the welfare implications of high protein prices. We are
used to thinking about economic development as a process of transformation, which can be
measured in terms of some universal indicators: the share of agriculture in GDP, for
example, or the degree of urbanization, all of which provide the foundations for greater
affluence. But, there is also a strong nutritional dimension to development. Beyond basic
food security, which may be provided even by a carbohydrate-dominated diet, economic
development is closely associated with the increasing significance of protein in people's
diets, which in turn is driven by the decreasing relative prices of protein sources. India has
certainly experienced phases when this has taken place - for example the surge in Milk
production that was termed the White Revolution - but the analysis presented above
suggests that these trends have not been sustained. Rapid economic growth is contributing
to the emergence of persistent demand-supply imbalances which, in turn, are making
proteins more expensive. In the absence of a significant positive supply shock, this might
result in the weakening of the economy's most productive resource - its people.
Concluding comments
Increasing demand for proteins appears to be an inevitable consequence of rising affluence.
The availability and affordability of proteins is, therefore, an important indicator of an
equitable and sustainable development process, with implications for both nutritional balance
and macroeconomic stability. To help achieve both objectives, a powerful supply response in
all sources of protein is needed. The Green Revolution succeeded in doing this for
carbohydrates. The White Revolution succeeded, at least for a while, in doing it for Milk.
Similar combinations of factors now need to be brought to bear on the goal of ensuring
protein security for the Indian economy.
Once again, my best wishes to Prof. Parikh and thank you all for listening to me.