Domestic Wheat Price Formation and Food Inflation in India

Inflation, especially in food prices, has been persistently high in India during the past twenty four months. This has been a source of concern to policy-makers. Fortunately, food price increases are now starting to ease, after the major spike that occurred in the wake of the severe drought of 2009. However, there still remains concern that we: (a) need to better understand the factors that drive such spikes in key prices; and (b) design more effective policies to prevent such future price spikes. The main approach to understanding inflation and its drivers has typically rested, on the whole, in assessing aggregate macroeconomic (aggregate supply and demand) conditions, which then typically leads to consideration of macroeconomic and monetary) policies as the principal tool to deal with inflation surges. That may indeed be appropriate in most circumstances, but is often a blunt, sometimes costly instrument that can stifle growth, especially if price pressures arise from (temporary) supply constraints. Therefore, it may be important to complement an aggregate macroeconomic analysis of inflation with microeconomic analysis: to ascertain if inflation is being driven by specific price spikes in important food and non-food commodities, which has the potential to drive other commodity prices in a cost-push manner. This paper, on global wheat market developments, price transmission and impacts on Indian domestic markets, as well as an assessment of public policies to manage domestic prices, is part of a larger effort to improve our in-house (Department of Economic Affairs) research---to track, monitor and forecast fast-moving key macro-economic variables with potentially large consequences for public policy. We have begun to intensify our efforts. We are investing further systematically---to understand growth and inflation dynamics in the context of rising food inflationary pressures in India and worldwide. We are capturing more high frequency data, and applying quantitative modeling tools (as evident in our current Economic Survey). We take up wheat in this paper, because of recent rapid price rises globally, as well as domestically, and because it constitutes a major element of the overall wholesale and consumer food price inflation indices. Some aspects of the price formation and policy intervention processes in wheat are also likely to be structurally similar for other similar classes of important food items (such as rice), permitting broader insights. Our paper draws upon existing theoretical insights and modeling attempts in the literature; it is, nevertheless, useful to note three “biases” in our approach: (a) favoring analysis of short-term, high-frequency price formation (daily, monthly, or quarterly), versus alternative longer-term annual, structural models; (b) favoring simplified reduced form forecasting models that track high-frequency turning points well, over more elaborate models and tests of longerduration time-series data (which may tend to be more historical and backward-looking, and less useful for short-term forecasting); and (c) assessing current India-specific public interventions in greater detail, than in more general academic papers and models.