A new crisis has been building, born in the pandemic, sparked by the Russia-Ukraine conflict, and exacerbated by sanctions. The world’s agricultural industry is in a major short supply, and food prices globally have been skyrocketing.
Global food prices have jumped >75% since 2020, and the situation keeps getting worse each month. Indian inflation too is being driven by higher food prices. That has now prompted the RBI to prioritise inflation-control over growth.
What’s up with the inflation situation in India, and how will the RBI stance change impact portfolios?
Food inflation globally
Russia and Ukraine together are very meaningful exporters of some of the key food items used globally.
Russia is the world’s largest wheat exporter
Ukraine accounts for a quarter of all the grains trade
Ukraine is the number one exporter of sunflower oil
Russia supplies more than a third of EU’s natural gas
Other than key commodities being in short supply, farm inputs too are massively crunched.
Fertiliser is more expensive thanks to natural gas prices spiking. The Nitrogen required to make most of the fertilisers comes from natural gas.
Diesel that fuels tractors is more expensive as crude prices shot up after sanctions on Russian oil.
Feed is more expensive, since it is dominated by corn.
These shortages make it hard for farmers to feed the world. The situation is worsening as Russia attacks the agricultural-heavy Eastern Ukraine, and as China faces COVID-related lockdowns in farming provinces.
Food inflation and India
In India, inflation has been rising, and that’s dominated news. More than 50% of the inflation index calculation is driven by food and beverage prices. Any increase in food inflation in India, directly increases the burden on households in the form of higher food prices.
In March 2022,
Consumer Price Index inflation stood at 6.95%
Inflation in food and beverages rose 7.47%
Inflation in oils and fats was at 18.79%
Vegetable prices rose 11.64%
But the India story may be a little different compared to the world
Globally natural gas prices have soared, impacting fertiliser prices (mainly urea, which is nitrogen based), and further upping food prices.
However, in India, a rise in urea prices does not have any bearing on the cost of farmers, and hence has limited impact on food inflation. Why?
India heavily subsidises urea prices. Since this is the most utiliser fertiliser, and India is very pro-agriculture, the government has capped the price of urea for farmers, at a fraction of its market cost.
In short, farmers buy urea at a heavily discounted price, which is fixed. The difference between the cost for farmers and the market price is something the government bears.
Simply put, most of the increase in fertiliser costs impacts the government’s expenditure, and hence its fiscal deficit, and not farmers >> consumers.
That said, all imports will be directly linked to global prices, and that price increase may drive market prices higher. But this is more true for stuff that is imported - like palm oil, which is a key ingredient for most of the packaged food companies.
So in a way, India is partly relatively shielded from some of the cost increases.
Will India benefit from the global supply shortage?
India is a major producer of wheat. In fact it produces more than it needs. Like the US stockpiles oil and Canada stores maple syrup, India has huge stockpiles of wheat.
With a third of the trade in wheat being impacted by the Russia-Ukraine conflict, there is an opportunity for India to start exporting wheat, given the high prices, and sufficient supply within our borders. The same applies to corn as well.
There clearly is an opportunity for India to fill the gap. That said, there are challenges too - shipping costs have increased as crude prices rise, there is a global shortage of containers, and a lot of the shipping routes have changed too.
Last year there was a global shortage of rice, and India had benefited from exporting its rice. To an extent where countries like Vietnam and China purchased Indian rice, for the first-time ever.
Food inflation is here to stay for a while
Despite factors being a little different for India, in terms of input costs, stockpiles and government intervention on pricing, food inflation still exists, and at high levels. It is important to note that while the factors appear to impact India lesser, they still are headwinds on cost.
Global shortages, increased fuel costs, supply chain restrictions, and the cost of imports will continue to impact food prices.
Pivot in central bank policy
The fears of persistently high inflation, which is above RBI’s comfort level sparked a change in central bank policy.
Although the RBI maintained rates at the same level, the RBI governor said it is now putting inflation control before growth. With this, we won't be surprised if the RBI starts reversing its rate policy to tame inflation.
Is Rupeeting prepared for rate increases?
Rate increases typically have a few immediate effects on asset classes:
Equities take a short term hit
Mid caps and small caps usually perform worse than large caps in this hit
Bond prices fall, more for longer duration bonds compared to shorter maturity
We have been prepared for this since the beginning of the year by doing the following:
Increased proportion to large caps versus mid caps
Moved from 10 year government bonds to 5 year ones
Added exposure to corporate bonds and SDLs by picking up some credit risk in a hunt for yield
Maintained exposure to Gold as risk aversion increases and gold prices start moving up