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Wrong antidote

May 15, 2008

Inflation continues to be the principal concern of policy makers in the country. Prices of vegetables, lentils, rice and wheat—the staple of most consumers in India—have shot up over the last few months, eating into household budgets. At an aggregate level, the Wholesale Price Index, which comprises three different product categories (food, fuel, and manufactured goods), had risen from 3.79 per cent three months ago to 7.6 per cent end of April. Needless to say, rising inflation has become a political hot potato. While the Reserve Bank of India is trying to tackle inflation from the monetary side, the government is using its executive powers to physically restrain price rise, for example, by holding down prices of fuel oils, steel and cement, and banning trade in agri-commodity futures.

To what end? Ban on futures doesn’t help anyone
Ban on futures doesn’t help anyone
Executive fiat may help dampen inflation in the short run, but it is hardly a long-term solution. Take, for instance, the ban on agri-commodity futures. Earlier this year, the government banned futures in rice, wheat, urad, and tur, and followed up with a ban on four more items in May, including chana, soya oil, rubber and potatoes.

What happened? Prices didn’t soften; in fact, the second set of ban actually led to prices of vegetable oils shooting up. Clearly, the government is barking up the wrong tree. Far from contributing to price inflation, a futures market helps discover future price and thus prevents prices from shooting up. On the contrary, the absence of a futures market would end up confusing both consumers and producers; the consumer would not know whether to curb or find substitutes for a particular item of consumption, while producers won’t know whether they should increase or decrease supply of the commodity in the market.

Interestingly enough, the Abhijit Sen Committee, which was set up to study the impact of futures trade on commodity prices, hasn’t found any evidence to show that futures trade is abetting inflation. The committee members, except Sen himself, are against a ban. Even Finance Minister P. Chidambaram, no country bumpkin, has gone on record to say that there may be no causal effect between futures trading and prices shooting up. “If rightly or wrongly, people perceive that futures trading in commodities is contributing to a speculation-driven rise in prices, then in a democracy, you will have to heed that voice,” he said at an Asian Development Bank meeting in Madrid recently.

Chidambaram has got it wrong. What the country needs is to help farmers increase food production, and not deny them and the consumers the presence of an efficient market place.

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