I have earlier written here about problems of inflation caused by agriculture sector. Actually high and persistent food inflation in India is due to mis-allocation of credit towards agriculture sector. So I ran a regression between Agriculture GDP and credit to Agriculture sector
The table above shows that Agri-Credit and Agri-GDP are correlated with high R-square, low p-value and so on. What is more interesting is that Agriculture credit is correlated with a factor of 0.29x with Agri GDP. In simple terms, every 1 Rupee increase in Agri credit results in 29 paise increase in Agri-GDP. This clearly shows mis-allocation to the sector. How does this happen? RBI's mandate for say a 15% credit growth and fixed priority sector lending norms for agri and allied sector result in agriculture credit growing by the same amount. Over the past 12 years, agri credit has grown 10-fold, i.e. CAGR of 21%. This is much higher growth rate than the sector can absorb.
Let us explore where this money (loan or equity) goes. A farmer uses various inputs seeds, fertilizers, tractors, etc. Most of these are purchased on loan. After 6-8 months, farmer is able to sell his product and repay the loan (or revolve it for the next farming cycle). Now we are increasingly stuffing more loan into this shrinking (in terms of farm sizes, area cultivated and so on) segment. The input companies figure out availability of cheaper loans and aggressive lending by banks and hence have incentive to increase the prices at will. This is precisely what has happened in India. Look at prices of tractors, fertilizers, seeds over last 10 years and you would know.
In a free market system, rampant increase in input prices would result in shrinking margins of the producer and he would restrict the usage of these inputs or look for cheaper alternative. But in India Government decides minimum support prices (MSP), which basically compensates for increase in input prices. So, who benefits? Banks, input companies. And who pays? Every citizen - he borrows at higher cost to compensate for incentives to agri sector and occasionally absorbs the losses due to defaults.
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| Regression between Agri Credit and Agri GDP for FY01-12 |
The table above shows that Agri-Credit and Agri-GDP are correlated with high R-square, low p-value and so on. What is more interesting is that Agriculture credit is correlated with a factor of 0.29x with Agri GDP. In simple terms, every 1 Rupee increase in Agri credit results in 29 paise increase in Agri-GDP. This clearly shows mis-allocation to the sector. How does this happen? RBI's mandate for say a 15% credit growth and fixed priority sector lending norms for agri and allied sector result in agriculture credit growing by the same amount. Over the past 12 years, agri credit has grown 10-fold, i.e. CAGR of 21%. This is much higher growth rate than the sector can absorb.
Let us explore where this money (loan or equity) goes. A farmer uses various inputs seeds, fertilizers, tractors, etc. Most of these are purchased on loan. After 6-8 months, farmer is able to sell his product and repay the loan (or revolve it for the next farming cycle). Now we are increasingly stuffing more loan into this shrinking (in terms of farm sizes, area cultivated and so on) segment. The input companies figure out availability of cheaper loans and aggressive lending by banks and hence have incentive to increase the prices at will. This is precisely what has happened in India. Look at prices of tractors, fertilizers, seeds over last 10 years and you would know.
In a free market system, rampant increase in input prices would result in shrinking margins of the producer and he would restrict the usage of these inputs or look for cheaper alternative. But in India Government decides minimum support prices (MSP), which basically compensates for increase in input prices. So, who benefits? Banks, input companies. And who pays? Every citizen - he borrows at higher cost to compensate for incentives to agri sector and occasionally absorbs the losses due to defaults.
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