Wednesday, August 28, 2013

Impact of the Food Security Bill on the Indian Economy


In the previous article we took a look at the impact the Food Security Bill will have on our budget. The amount of money we will end up spending, where we will get the money and so on. To quickly recap, the Food Security Bill is going to offer rice, wheat and other food grains at heavily subsidized prices which will result in an expenditure of around 1.2 to 2.4 lakh crores. So, now we know that our government is keen on pushing for this scheme and in the next few months it will eventually be put in practice. We will start incurring this huge expenditure which invariably will have a significant impact on our Economy.

The idea behind this article is to analyze the impact this will have on the various aspects of our Nation’s Economy...

Impact on Economic Growth:

Remember the last section from our previous article on how the government will fund this huge expenditure? The government would resort to borrowing to fund it. When the government enters the borrowing market, in order to entice investors, it would have to offer good interest rates. The private sector too would have to hike their interest rates in order to stay competitive. This means, the Interest Rates will continue to remain high. High Interest rates is never good for economic growth.

Verdict:


Impact on Food Inflation

Have you heard of the term - "Minimum Support Price or MSP"?

This is something the government sets/declares every year as the price at which it buys grains from farmers. This grain is then used by the government for all its various schemes. The grains to be distributed under this Food Security Program too will be procured like this.

Minimum Guaranteed prices means, farmers will have more incentive to grow rice/wheat and other grains covered under this scheme. This might result in Vegetable production getting affected which will further affect the nation’s Food Inflation.

In the last 5 years, food inflation contributes to over 41% of our overall Inflation. So, by subsidizing the price of rice, wheat and a few cereals, it might result in an unintended consequence of other items becoming costlier which will result in overall higher food inflation.

Verdict:

Impact on Overall Inflation:

An alternate to funding this scheme is for the government is to "Print Money". World History is full of classic examples where governments resorted to printing more currency to fund its cash requirements. This is never a good idea and will result in the country's overall Inflation going higher.

Let us just hope that the finance ministry does not resort to this technique otherwise our economy would be doomed for a very long time

Verdict:

Impact on Savings

Higher food prices mean higher inflation. Higher inflation means people will end up spending a higher % of their income to meet their day to day needs. This will result in much lower savings.

Verdict:

Impact on Economic Growth

Lower Savings and lower surplus income means - people will spend a lower amount of money on consuming good and services and therefore the economic growth will slow down further.

Verdict:

Impact on the Current Account Deficit:

We all know that Importing of Gold and Petroleum products is the biggest contributing factor to our nation’s Current Account Deficit. Right?

The Food Security Bill guarantees food for the people covered under the scheme. So, if in a particular year, the in-country production of either rice or wheat is not sufficient we would be forced to import it. So, if we start importing rice, wheat or any other food grains, it will further widen the Current Account Deficit.

Verdict:

Impact on the Rupee

The Rupee is bleeding left, right and center. It is falling freely and god knows when it will stop. Anyways, lower savings and wider current account deficit will impact the rupee.

If India does not save enough money, it means that, we will have to borrow capital from foreign countries/investors. When these foreign borrowings need to be repaid, it will almost always be using dollars. This will put pressure on the rupee and lead to further depreciation against the dollar.

On top of this, buying rice or wheat from the international market means, we will be paying in dollars. This will lead to increased demand for the dollar and result in further depreciation of the rupee.

Verdict:


Impact on Fertilizer and Power Subsidy:

In order to grow food grains, farmers use fertilizers and electricity. Both of these items are already heavily subsidized for farmers. The procurement needs of the Food Security Bill will result in intensive cultivation using more fertilizer and power, which will push up central subsidies on fertilizer and state subsidies on power.

So, in order to procure enough food grains, the government will be forced to shell out more subsidies for both fertilizers and power which again will leave a big dent in the nation’s budget

Verdict:



Some Final Words:

As you can see, the Food Security Bill will have a significant negative impact on almost every aspect of our economy. The impact is huge and with high inflation, slow economic growth and depreciating rupee, the chances of the stock markets regaining its upward momentum are very slim as of now.

With the market going down by more than 2000 points in the past couple of weeks, some amazing investment opportunities have turned up. However, the market is not for the faint of heart right now. As of now, things don’t look very bright and hence further downside is a very real possibility. So, if you are looking at investing in the stock markets, be cautious and split up your investments across a wide time period to average out your cost. Do not invest money that is earmarked for emergencies into the market in the current volatile scenario. Keep it as cash in your bank account or park it in a bank FD.

Invest only in blue-chips or large organizations whose stock prices are much more stable than mid or small cap companies. Stay cautious.

Happy Investing!!!


Disclaimer: The idea behind this article is not to cover the political motives of either the ruling party or the opposition. This article is my personal opinion about this Food Security Bill purely from an investment and economic stand point. The author does not guarantee the accuracy of any of the claims in the article.

2 comments:

  1. Hi Anand,

    This is a very neat summary on the impact of the food bill. I particularly like you down-to-earth language and appropriate use of graphics. Your blog is now o my reading list. Continue to write more interesting articles on the Indian economy! I feel there are not enough good quality independent analysts who give their view on the happenings - so keep up the good job!

    AM

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    1. Thank you Abhijit. Dont forget to like the blogs facebook page so that you will get an update on your facebook newsfeed everytime a new article is posted on this blog...

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