A food inflation story beyond weather

High food inflation is a major concern in India, with the weather taking much of the blame. However, the multiyear food-price surge goes beyond just rainfall or heatwaves.

India’s food inflation episodes warrant a broader lens, considering farm input costs, per capita income growth, food demand, and logistical costs. These factors are more predictable and intricately linked to food inflation trends – and even suggest food inflation may fall in 2025.

Over the last decade, food inflation in India has seen two distinct phases. It trended lower between 2014 and 2019, hitting its lowest point in mid-2019. However, it then surged in 2020 due to pandemic-related disruptions. In 2021, food inflation ebbed on easing lockdown restrictions but spiked again in 2022 and has since remained high.

Interestingly, the decline in food inflation between 2014 and 2019 occurred despite significant monsoon deficits during 2014 to 2018 and rising average-surface temperatures. Conversely, food inflation rose in the past five years, despite only two years of tolerable monsoon deficits (2021 and 2023) and no significant rise in average surface temperatures. The severity or frequency of heat waves also does not fully explain the food inflation trend.

Agricultural input cost inflation offers a more fitting explanation. Bloomberg’s India agricultural input cost inflation has a high 67 per cent correlation with consumer price index (CPI) food inflation, but with a 14-month lag. The correlation is high for CPI food categories such as cereals, spices, milk, and vegetables, but the lag varies.

Farm input cost inflation started declining in 2012 and was negative between 2015 and 2018, helping reduce food inflation. However, it began rising again in 2019 and surged in 2022 on the back of the conflict in Ukraine. Most of the cost pressures came from fertilisers, diesel, and electricity.

Fiscal subsidies to farmers (such as for food, power, and seeds) can mitigate the impact of commodity prices on farm input costs but can also distort and delay their passthrough to consumer food prices. For instance, enhanced fertiliser subsidies cushioned the surge in global fertiliser prices in 2022. Yet farm costs remain susceptible to market prices, such as diesel prices due to excessive reliance on diesel-run engines for water pumping and harvesting.

Food trade margins – the difference between retail and wholesale prices of food items – have also played a role in elevated food prices. Since 2020, food-trade margins for staples like pulses, cereals, sugar, vegetables, and milk have increased sharply. The average margin index surged 40 per cent in 2021 compared to March 2020, and remains 23 per cent above pre-pandemic levels. Factors such as logistical costs and demand have been crucial in keeping food trade margins elevated.

The pandemic disrupted food supply chains, allowing retailers to raise profit margins. With lockdowns limiting spending options and triggering panic buying, food demand outpaced supply, pushing food prices higher.

Although margins started to fall in 2021 as lockdown restrictions eased, they remained sticky into 2022 due to rising transport costs. Domestic diesel prices climbed 6 per cent in 2020, 24 per cent in 2021, and 5 per cent in 2022, coinciding with global energy price spikes and food shortages caused by the conflict in Ukraine. Domestic diesel prices have a strong historical correlation with food margin trends.

India’s food demand has strengthened since 2018-19, contributing to rising food prices. Though domestic food demand indicators are scant, US Department of Agriculture data show a strong uptick in annual consumption of wheat, rice, and sugar in the past few years. The pace of increase is reminiscent of the surge seen in 2013, when food inflation was in double digits. Among many factors, per capita income growth may be driving the increase in consumer food demand. Given India’s low middle-income status, food demand is elastic to income.

India’s per-capita income growth slowed from over 6 per cent to close to 3 per cent between 2016 and 2019, curtailing food demand growth at a time when farm input costs were also evolving favourably for inflation.

The pandemic-induced economic downturn aside, India’s per capita income growth has picked up sharply in recent years, averaging 7.2 per cent between 2021 and 2023. This rise in income and expanded public food programs to address hunger have driven consumption and inflation.

While the importance of weather and climate for determining food prices cannot be trivialised, these variables are difficult to model and offer limited guidance for future food price trends. This makes it harder for central banks to set forward-looking policy confidently. This suite of economic factors offers an alternative.

Encouragingly, agricultural input cost inflation has dropped sharply in 2024 and will help reduce food inflation in 2025. Food trade margins are easing, and global energy prices are falling, easing logistical pressures. Per-capita income growth and food demand will also likely cool off, in line with GDP growth trends.

In short, the overall food inflation ecosystem has improved. These developments, along with benign inflation excluding vegetable prices, could give the Reserve Bank of India the confidence it needs to lower interest rates at its next policy meeting - especially now gross domestic product growth has undershot their optimistic projections sharply, hinting at a negative output gap in the economy.

Dhiraj Nim is an Economist at ANZ Research