Dear Beni Prasad, it's govt, not farmer, who benefits from inflation

“Beni Prasad Verma is not a particularly bright fellow,” said Mohan Guruswamy, Chairman of the Centre for Policy Alternatives, a New Delhi-based think tank, on Times Now late last night.

The remark was in reference to Verma’s comment that “dal (pulses), atta (flour), rice and vegetables have become expensive. The more the prices, the better it is for farmers. I am happy with this inflation…Media says the cost of food has increased, but it is benefiting farmers… and the government is in favour of farmers’ profit.”

Verma is the Union minister of steel.

There are several logical inconsistencies in what Verma said during the course of the day yesterday. An increase in food prices and the farmer benefiting from it are two very different things. As we know, the farmer does not sell his produce directly to the consumers. His produce goes through a series of middlemen. That being the case, it’s the middlemen who buy agriculture produce from farmers, who might be gaining the most from a rise in price. And not the farmer. This has been the case in the past whenever India has seen a shortage of onions.

But what if the farmer is benefiting from the rise in price? This means that the farmer is actually able to sell his produce at a higher price. Even then Verma’s statement does not make sense.

It does not take into account the fact that a normal farmer does not produce all the goods he consumes. So a rice farmer may not be farming vegetables. And a vegetable farmer may not be producing dal and so on. Hence, a rice farmer might gain when the government announces a higher minimum support price for rice, but he loses out because he also needs to buy dal, vegetables, sugar and so on. And the prices of these food products have also been going up.

[caption id=“attachment_425091” align=“alignleft” width=“380”] If government benefits from inflation, the farmer is not the real gainer. This is something that Beni Prasad Verma either does not understand or is hoping farmers won’t understand.[/caption]

The latest inflation number based on the consumer price index was released today, and it shows inflation down marginally for July 2012 at 9.86 percent. This means that prices on the whole were up by 9.86 percent in the month of July 2012 in comparison to July 2011.

The inflation for July 2012 was marginally down from June. Within this the food price inflation stood at 11.53 percent. It is actually up from 10.71 percent in June 2012.

The point I am trying to make is that farmers, other than growing what others eat, also eat what other farmers grow. This is a basic fact that Beni Prasad Verma did not realise while making the statement that he did. And if food prices on the whole went up by 11.53 percent in July 2012, it surely does not benefit farmers because other than being producers of food products, they are its consumers as well.

Now that’s one part of the argument.

If we accept that high inflation hurts farmers to the extent they are consumers, they will cut down on their planned spending as prices rise. This, in turn, hurts businesses and the overall economy. Businesses do not like to spend money on newer projects as consumers cut down on consumption.

So the question is who benefits in an environment when inflation is high? “The most obvious beneficiary of higher inflation, at least in the short term, is the government… The government will always be able to pay its debt, at least domestically, since higher inflation effectively reduces the long-term cost of borrowing money,” writes Kyle Bumpus in an article titled Who Benefits From Inflation?

Let’s take a look at this statement in the context of India. The return on a 10-year government bond as I write this is around 8.22 percent. The government essentially issues bonds to finance its fiscal deficit - the difference between what it earns and what it spends.

The consumer price inflation for the month of July 2012 has come in at 9.86 percent. What does this mean? This means that the government can effectively raise money from the market at the rate of 8.22 percent when inflation is higher. This effectively means that the real rate of interest is negative at -1.64 percent.

This means the yield that the government offers on its bonds is even lower than the rate of inflation. So technically investors who are buying government bonds are effectively losing money. The question is why are investors then ready to buy government bonds which pay an interest rate lower than the prevailing rate of inflation?

“Negative real rates may simply indicate that savers are incredibly cautious, and that businesses are reluctant to invest in new projects,” wrote The Economist in a recent edition. “When an economy is growing rapidly, there should be an abundance of profitable investment opportunities. Businesses are happy to borrow at high real rates, confident that they can still earn an even higher return,” it added.

But given the state of the economy right now, businesses and savers would rather buy government bonds and lose a little money on it rather than invest it anywhere else. This demand for government bonds allows the government to pay a rate of interest which is lower than the prevailing rate of inflation. In the strictest sense of the term the government is getting paid to borrow.

If government benefits from inflation, the farmer is not the real gainer. This is something that Beni Prasad Verma either does not understand or is hoping farmers won’t understand. It’s time he listened to the only Hindi film song written on inflation from the movie Roti, Kapda Aur Makan, written by Verma Malik, “Baakee Kuch__Bacha__Toh Mehangayi Maar Gayi”. If any money is left, inflation eats it up.

Vivek Kaul is a writer and can be reached at vivek.kaul@gmail.com