Contents

Abstract ................................ ................................ ................................ ................................ ............. 2 Section 1: Introduction ................................ ................................ ................................ ...................... 3 Section 1.1: Wheat Market The Scenario in India ................................ ................................ ........ 3 Section 1.2: Wheat Production Trends in India................................ ................................ ............... 3 Section 1.3: Wheat It s Marketing Channels in India ................................ ................................ .... 4 Section 2: Literature Review ................................ ................................ ................................ .............. 5 Section 3: Factors Affecting Demand and Supply of Wheat in the Indian Market................................ 6 Section 3.1: Infrastructural and Technological Constraint................................ ............................... 6 Section 3.2: Expected Price and Hoarding ................................ ................................ ...................... 7 Section3.3: Effect of Supply Disruption: Great Russian Heat Wave 2010................................ ......... 9 Section3.4: Effect of Substitutes on Wheat: Corn as Biofuels................................ ........................ 10 Section 4: Policy Recommendations................................ ................................ ................................ . 12 Section 5: References ................................ ................................ ................................ ...................... 14

Abstract
World market prices for major food commodities such as grains and vegetable oils have risen sharply to historic highs of more than 60 percent above levels of just 2 years ago. Many factors have contributed to the run up in food commodity prices. Some factors re ect trends of slower growth in production and more rapid growth in dema that have contributed to a tightening of world nd balances of grains and oilseeds over the last decade. Recent factors that have further tightened world markets include increased global demand for biofuels feedstocks and adverse weather conditions in 2006 and 2007 in some major grain and oilseed producing areas. This study intends to investigate the reasons for the gap between the demand and supply of wheat in the Indian market due to shocks both within and outside the country and its possible implication on the price of wheat in the market. Towards the end, certain policy recommendations have been provided. Key Words: Demand, Supply, Inflation J.E.L Classification: Q11

Section 1: Introduction
Section 1.1: Wheat Market

The Scenario in India

The agricultural sector in India accounts for an important part of its GDP As of 2010, agriculture contributes 19 percent to the total GDP of the country and employs nearly 60% of the population. India is responsible for approximately 12 percent of the global wheat production, thereby making it the second largest producer of wheat in the world. It is also second to China, in terms of wheat consumption.

Section 1.2: Wheat Production Trends in India

Wheat is one of the most important staple food grains in India. The country produces about 70 million tonnes of wheat per year or about 12 per cent of world production. It is now the second largest producer of wheat in the world. Being the second largest in population, it is also the second largest in wheat consumption after China, with a huge and growing wheat demand. More than 95 percent of the wheat producing area in India is situated to the north of a line drawn between Mumbai and Kolkata and small amounts are also produced in Mysore and Chennai. The major wheat producing states in India are placed in the Northern hemisphere of the country with UP, Punjab and Haryana contributing to nearly 80% of the total wheat production. Production of wheat in India has shown a rising trend in the past five decades. The Green Revolution in the 1960s contributed to the phenomenal rise in wheat production due to high yielding seeds and use of better technology in the production processes. The spectacular yield growth recorded in the post-Green Revolution years in Punjab and Haryana receded into history during mid 1970s when wheat production stagnated. Food grain production in the frontline agricultural states of Punjab, Haryana and western Uttar Pradesh, comprising the country's food bowl, decelerated. However, from the 1980s wheat production has picked up and has been growing at a steady rate ever since. But, as we can see form the graph below, wheat production has again been showing a declining trend post 2008-09. This can be attributed to a lot factors both internal and external as is discussed in section 3 of the paper.

Figure 1: Production trend of wheat in the last decade

Source: www.indiastat.com

Section 1.3: Wheat It s Marketing Channels in India

Figure 2: Marketing channels of wheat in India

There is a wide range of active channels of wheat in the Indian market. Agencies such as the Food Corporation of India (FCI) help the Government to store the procured wheat from the farmers. The wheat is then distributed through the State Public Distribution System (PDS) to the marginal and the BPL families. The FCI has the advantage of procuring nearly 18% of wheat from farmers. It also maintains buffer stocks in the Central Pool, thus contributing to price stability. Moreover, export of wheat in India is also regulated by the Government.

Section 2: Literature Review

y Market Supply is the horizontal summations of all the supply curves in the market, while the Market Demand is the horizontal summation of all the demand curves in the market. y Price Elasticity of Demand is the percentage change in the quantity demanded of a good in response to a one percent increase in the price of the good.

Price elasticity of demand, Ep = - (

When the magnitude of price elasticity is greater than 1, the good is said to be highly elastic in nature and when it is less than 1 in magnitude, the good is considered inelastic. Higher elasticity tends to make the demand curve go flatter while lower elasticity implies a steeper demand curve. Wheat being an essential commodity, the Demand Curve is shown to be steeper than the supply curve for all purposes in the study.
y

The theory of Self Fulfilling Expectation states that if it is expected that prices will go up in the future, the prices do go up in the future thus fuelling greater inflation than expected.

Section 3: Factors Affecting Demand and Supply of Wheat in the Indian Market
In recent times the wheat prices have been spiraling to an all time high. The rising demand supply gap can be attributed to a wide number of factors working both within and outside the country which affect the market demand or supply of wheat. Some of these factors are discussed in this section. Assumption: For all further analysis we assume India to be an Open Economy i.e. India engages in the import and export of goods and services. Thus, the demand and supply of wheat in the country is affected by factors prevalent in foreign as well as in the home market. Moreover, considering wheat to be an essential commodity its quantity demanded does not change drastically with changes in price. Thus, the demand curve of wheat is taken to be relatively inelastic and is shown by a steeper demand curve.

Section 3.1: Infrastructural and Technological Constraint

A wheat stockpile in India that could feed 210 million people for a year got spoilt because the government lacked enough warehouses to store it. According to a government estimate obtained by The Associated Press, 17.8 million metric tons of wheat is exposed to the elements of nature i.e., it is stored outdoors, under tarps during India's monsoon season. The wheat could alleviate hunger in a nation where one in every two children is malnourished. As it got wasted, it promised to drive global wheat prices up 78 percent approximately. The government, faced with options more unpalatable to it than rotting food, let the mountain of wheat grow. Exporting the grain would have been politically explosive because food inflation had been in the double digits for months. The government buying less wheat from farmers in a country where over half the population makes its living off the land is equally untenable. Selling more at subsidized prices to the poor is off the table because it would add to a swelling fiscal deficit. India is the world's second largest producer of rice and wheat, but it tightly controls exports. In 2007 it banned exports of wheat and non-basmati rice, except for humanitarian purposes. The northern states of Haryana and Punjab, India's grain basket, have 173,668 metric tonnes of wheat that s been sitting under tarps for three or more years, and another 5.0 million metric tonnes is now being pummeled by its second monsoon, according to the document. Punjab state officials have admitted that 49,000 metric tons of wheat is already unfit for human consumption. The Food Corporation of India maintained that it cannot distribute grains to the needy because states don't have enough local storage capacity. Already overstuffed state warehouses haven't even been able to take adequate rat control measures. The government had decided to release more subsidized rice and wheat to the states, but it's unclear whether it will end up in people's stomachs because of the inefficient public distribution system.

This incident has adversely affected the aggregate supply of wheat grains in the Indian market which can be shown by a simple demand curve analysis as given below. The rotting of wheat grains due to inefficient storage and warehousing has led to the supply curve shifting to the left thus reducing the quantity sold and inflating the wheat prices.

Price
D S S P1 P0 S S D 0 E E

Quantity

Figure3: Deficient supply due to technological constraint

Section 3.2: Expected Price and Hoarding

According to theory, we know that if a consumer expects prices to go up in a particular period, he will consume more now in order to avoid the price rise. However, greater consumption now fuels demand which in turn raises the market equilibrium price and thus the expectation of a price r ise gets fulfilled. The above theory was exactly replicated in the wheat market recently when due to rising inflation during the past few years, government and individuals engaged in speculative buying which led to large scale hoarding of wheat grains. This speculative buying in turn has reduced supply in recent times which has further created inflationary pressures. This phenomenon can b shown through e Figure 3 and Figure 4 where hoarding of wheat grains has let to holding back of supply and thus caused the supply curve to shift towards the left.

Figure 4: Trend of Minimum required and Actual stocks of wheat

While we clearly see that the actual stock of wheat available on 01.01.2009 is close to the 180 million tonnes mark, the minimum buffer stock required in accordance with the Government Policy is approximately 80 million tonnes, which is less than 50 percent of the former. It is evident that hoarding of the excess has taken place, owing to an expected rise in future prices. On the other hand, individual smaller channels such as various commission agents at mandi level, stockists, semi-wholesalers, retailers, manufacturers, bread makers, flour mills, etc. account for the marketing of the balance 82% of the country s wheat produce. A point to note here is that the phasing out of Government s involvement in the wheat market would result in an increased participation of the private sector in this market thereby reducing Government subsidy in the wheat market, while also alleviating burden of the Government in this area. GOVERNMENT POLICY REGARDING WHEAT Since wheat prices at the procurement and disposal levels are placed in the control mechanism with well defined objectivity, scope of general price trend analysis also becomes Government policy centric. The related price in the open market is related to the traded prices. POLICY OF MINIMUM SUPPORT PRICE (MSP) The policy of MSP is a critical policy component of the Indian Agricultural Economy. Government works out the MSP giving due consideration to all the economic factors like cost of input, power, capital and labour with reasonable going margins. The minimum support prices are announced by the Govt. of India with a view to ensuring remunerative prices to the farmers for their produce on the basis of the Commission for Agricultural 8

Costs and Prices (CACP) recommendations. The minimum support prices are perceived by the farmers as a guarantee price for their produce from the Government. These prices are announced by the Government at the commencement of the season to enable them to pursue their efforts with the assurance that the prices would not be allowed to fall below the level fixed by the Govt. Such minimum support prices are fixed at incentive level, so as to induce the farmers to make capita l investment for the improvement of their farm and to motivate them to adopt improved crop production technologies to step up their production and thereby their net income.

Section3.3: Effect of Supply Disruption: Great Russian Heat Wave 2010

Russia is the world s third largest wheat producer and accounts for about 8.1% of the total world production. It exports about 30% of its production which represents roughly 11% of the total wheat exports. Currently one of the worst droughts in decades has already de stroyed 20 percent of the Russia s wheat crop, and there are fears that more fields will be lost due to recent wildfires in the western part of the country. Considering that Russia accounts for roughly 8 percent of the world s wheat production, the current loss is equivalent to a 1.6-percent decrease in the global wheat supply. The problem has been compounded by the fact that Russia has imposed a grain export ban through till the end of the year. A direct outcome of this decision has been a rally in the prices of wheat as shown in the table below.
2010 January February March April May June July August US $/Ton 198.72 192.17 191.87 186.86 190.03 182.34 210.92 253.34

Table 1: Table showing price of wheat in $ in 2010

Source: http://www.fao.org/es/esc/prices

Figure 5: Projected Supply and Demand for wheat due to Russian crisis

A direct effect of the Russian crisis will be a decline in supply of wheat by about 2.2% of the total wheat output that is from an output of 650 million tonnes to about 635 million tonnes. Hence we see the expected supply curve shifts to the left. Also due to the export ban by Russia, there is a temporary shock among traders and expectations of higher prices has shifted the demand curve to the right. The resultant equilibrium price now hovers around $250/tonne as compared to a price of $200/tonne in early July. India being an open economy is also bound to feel the repercussions of the reduction in supply due to this crisis. Once again, as shown in figure 3, a deficient supply situation will put pressure on the prices and lead to an inflationary situation.

Section3.4: Effect of Substitutes on Wheat: Corn a s Biofuels

For quite some time, the world has been hunting down for suitable low cost alternatives for petroleum products. An effort in the same direction was to use crops and convert them to fuels, popularly called as bio-fuels. With the green brigade gaining momentum and growing awareness about environmental conservation, there was a rapid increase in the demand for bio-fuels like bioethanol from maize or corn and sugarcane. About 20% of the maize (corn) produced in the United States was being used to produce bio-fuels in 2007. There was sustained increase in demand for maize owing to the continuous production of ethanol from maize. This resulted in reduced quantities of maize being available for food and feed for animals, thus stimulating increased prices for maize. On the supply side, this made maize more profitable to grow and hence some farmers shifted from rice and wheat cultivation to maize cultivation.

10

rice rice

Figure 6: Supply and demand dynamics of wheat due to the effect of use maize for biofuels Now analyzing the effect of bio-fuels on the market forces of wheat as shown in the figure above, the reduced food supply in the international market owing to maize being directed away for bio fuels, resulted in increased demand for wheat and rice, thus shifting the demand curve for wheat to the right. Further, reduced area under production reduced the supply of wheat in the market thus causing the supply curve of wheat to shift to the left. As a result, we saw wheat prices increase manifold. This has also been empirically justified through as shown in the following diagram where wheat prices zoomed past the $300/ tonne in late 2007. Similar to the international trend the demand and supply forces in India also reacted and prices spiralled up.

Figure 7: Sustained wheat price increase in 2007

Thus, we see that although inefficient storage did lead to a reduction in supply and pushing up of prices, the inflationary effect was exaggerated by further reduction in supply due to expected future price and hoarding. If we look at the international scenario and its effect on the Indian market demand and supply curve, both a reduction in supply and an increase in demand has been responsible for continuous rise in prices of wheat. This cumulative effect has further magnified the 11

S S

E E S S D D uantity uantity

price rise and thus, this could be one possible explanation to the increasing wheat prices in recent times.

Section 4: Policy Recommendations

Today when we think of India s core competencies, what comes to mind is India s huge educated workforce, the ones who are working in the knowledge industries like information technology, financial services, etc. However, there is another sector where we could be a world leader. In fact, it was what made India one of the richest nations in the world once. It is the agriculture industry. India has vast fertile tracts of land, abundant supply of water, a huge workforce, coupled with a domestic market of a billion. Somehow a strange belief has garnered, that farming is not a business and farmers can never be businessmen. One of the arguments often given against economic reforms is that they are anti- poor, and that they do not benefit the people living in the rural areas or the hinterlands. The fact is that even though every politician may claim to be pro-poor, pro- farmer, none of them have done anything substantial for their progress. Australia is one of the largest exporters of wheat in the world. There have been instances where even India had to import wheat from Australia to meet the shortfall in its domestic market. Every year India loses wheat equivalent to Australia s annual production due to inadequate storage and distribution facilities. One suggestion could be loosening restrictions on foreign investment in India's retail sector -- where big corporations like Wal-Mart, Carrefour and Tesco are barred from selling directly to consumers -- could be the best way to get more storage space built. An example of how controls are hampering the growth of agriculture could be the Agriculture Produce Marketing committee act (APMC ACT) which restricts a farmer s ability to decide where to sell its produce. He cannot sell his produce across state borders directly and he is at mercy of middlemen at the mandis who are better organized than the farmer. The beneficiary of the recent system is neither the consumer nor the farmer but the middleman, who despite massive inefficiencies make unreasonable profit margins. For India to grow at an 8-10% economic growth rate our agricultural sector has to expand. For that to happen there is a need for reforms in our agricultural sector in the way which calls for agricultural produce to be procured, stored and marketed, for huge investments in the supply and distribution chain and the most importantly, for ushering in competition in the supply and distribution chain where the farmer decides whom to sell and at what price. The government can always decide the ceiling price. India should open up its retail sector to foreign capital and competition. Foreign retailers would bring with them the best practices and investments in the supply and distribution chain and at the same time open up linkages to the global markets for Indian agricultural products. Modern retailers procure in bulk and sell at low prices. They thrive on reducing the inefficiencies in the supply chain bringing down the cost substantially for the consumers and getting a better deal for the farmer. The argument often given against FDI in retail is it will severely affect mom and pop shops; they won t be able to survive the competition. But we already have home-grown modern retailers like Big Bazaar, Nilgiri s etc. who are thriving along with the traditional kirana stores. So, in any case, we have modern retailers in the market. The Indian retail market is very different from the Western retail 12

market. In India consumers like to make purchases frequently and in small quantities. Instead of travelling to the large retail stores far from their own place of residence, people still prefer the convenience of the traditional neighbourhood kirana store. Kirana stores enjoy the advantage of good consumer relations built over a period of time. More over the kirana stores can buy from the cash and carry stores and reduce their cost of procurement. Agriculture still accounts for 60% of India s labour force and an improvement in the agriculture sector would directly benefit them. Allowing 100 % FDI in retail would lead to an agricultural revolution in the country much like what Green Revolution did.

13

Section 5: References
y y y y

www.indiastat.com www.economictimes.indiatimes.com Satya P. Das, Microeconomics for Business Gregory Mankiw, Macroeconomics

14