Why the RBI is taking tomato prices seriously
TOMATOES entered India about 500 years ago, spent a couple of centuries in neglect, and then suddenly picked up in the early 19th century. By the time William Roxburgh published Flora Indica in 1832, the tomato was already “very common in India.” Some three decades later, Birdwood’s Catalogue of Vegetable Productions of the Presidency of Bombay reported that “the fruit is eaten as a salad and a sauce.” In 1893, a report on the ‘Garden Crops of the North-Western Provinces and Oudh’ said, “The vegetable was coming more into favour with natives as an article of food on account of its acid taste.” Right now, tomatoes are omnipresent in Indian kitchens, acting as a souring agent and adding body to our curries and gravies. Indeed, butter chicken, probably our most famous culinary export, has more to do with tomatoes than butter.
So, when the price of tomatoes goes up, even the RBI has to take notice. Between May and June this year, the retail price of tomatoes increased by a whopping 64 per cent. Tomatoes alone accounted for nearly a quarter of the overall rise in retail prices in the month. In July, the price rise has been even worse, and now even onion prices are making eyes water. The RBI expects this to continue for another couple of months, till prices begin to moderate in October.
This is not very different from what happens every few years. Tomatoes are notoriously difficult to store. They spoil quickly in the refrigerator, where other vegetables thrive. They dry and shrivel at room temperature, especially in the summer months. They get squished and crushed while they are being transported. So, farmers have a very short window in which to sell their tomato crop and get the best price for it.
When there is a shortage — as there is right now — tomato prices shoot up. The price signal makes farmers grow more tomatoes in the next season. That causes a glut and farmers have to sell at low prices. In some cases, when prices crash, farmers simply dump their crop on the roadside instead of paying the cost of transporting them. This makes them reduce tomato cultivation in the next season. This causes a shortage and prices go up. And the same cycle is repeated.
In most years, governments do not care much. But every five years, the Centre wakes up, when general elections are around the corner. That is because every politician knows the voters’ psyche. They do not blame governments for unemployment nor for economic slowdowns. But they sure do so when it comes to the prices of vegetables.
In fact, food inflation is the key to consumer sentiment. We deal with food prices every day, as opposed to something like house rent, which goes up once a year. When tomato or onion prices go up suddenly and sharply, it makes people oversensitive to inflation. Fuel prices have a similar impact, again, because we buy petrol every few days. Prices of such items of daily or frequent purchase affect our ‘inflation expectations.’ If they go up sharply, we start expecting that inflation will remain high in the foreseeable future, and that affects all our consumption decisions.
That is why even though the RBI cannot do anything about food prices, its monetary policy has to take the prices of tomatoes seriously. The RBI’s interest rate decisions are based on mainstream economic theory, which says that inflation expectations are even more important than actual inflation. If workers expect prices to keep rising, they will demand more wages. This, in turn, will push up production costs and eat into corporate profits. Entrepreneurs will then have to increase prices to maintain profit margins, thus causing inflation. Thus, inflation expectations — whether real or imaginary — will act like a self-fulfilling prophecy, unless both investment and consumption demand are curtailed.
Central banks do that by increasing an entrepreneur’s cost of finance, by reducing the availability of loans. If the actual interest rates on loans go up, entrepreneurs will think twice before borrowing to invest. Consumers, too, will postpone their plans to take personal loans to buy homes, cars and big-ticket consumer durables. By tightening the flow of money — its liquidity — central banks can stop the economy from overheating. The pause on investment and consumption demand reduces the demand for labour and stops wages from rising too fast. The drop in aggregate demand helps reduce prices, causing inflation to ease. Mind you, none of these monetary strategies can affect the demand for vegetables. What they can change is inflation expectations as other things become visibly cheaper.
There are just six months left for election campaigns to begin in full steam. The government cannot afford to let prices become an election issue. So, it will have to bring retail inflation down, even if it is at the expense of economic growth. The RBI, despite its relative autonomy, cannot be entirely immune to the government’s political imperatives. That is why the central bank, which had been okay with inflation staying in the 6 per cent zone, now wants to bring it down to
4 per cent. It has taken a very small step by raising the incremental cash reserve ratio — the proportion of new cash that banks have to park with the RBI — to 10 per cent. The impact, as experts say, is going to be marginal. But it is a clear signal that the RBI will take bigger steps to squeeze liquidity to curb inflation, if it has to.
However, food inflation is a global phenomenon right now, which is expected to last throughout this year. It has happened because of climate change-induced crop failures, Russia’s Ukraine war causing a shortage of wheat and oilseeds, and also ‘price-gouging’ by giant multinational agri companies. In such a situation, the Centre might have no option but to impose price and trade controls. That might cost some votes of rich farmers and crop traders. But their number is too small to make any electoral dent.
The author is a senior economic analyst
