No Stopping RBI, ECB, And Biofuels In India

Food supplies have shifted rapidly from surplus to shortage, and the United Nations has again warned about the heightened risks of world hunger. Henry Boucher, partner and head of investment strategy at Sarasin & Partners writes in a Reuters article that even though supply disruptions in many parts of the world are severe, and policy solutions are challenging, western governments do have the opportunity to reverse the rising cost of food through the simple scrapping of biofuel mandates. This, according to him, would remove a very large non-food demand for crops and turn the current grain shortage into a surplus, easing the pressure on inflation.

This view also helps us bring a different prism to assess the ethanol movement in India. While the increased use of ethanol in auto fuels has helped producers, a close eye also needs to be kept on what it does to water levels in India, and possible diversion away from other land use. Sugarcane is a water-intensive crop, with some estimates averaging at 1,600-2,000 litres of water for the cultivation of each kilogram of sugar and one litre of ethanol from sugar requiring about 2,860 litres of water. Sugarcane and paddy combined consume 70% of irrigation in India, prompting the NITI Aayog to advise providing suitable incentives to farmers for shifting some of the area under sugarcane to less water-intensive crops.

This will be a difficult task, given that sugarcane is a profitable cash crop for cultivators. The government’s argument is that the push for ethanol poses no threat to India’s food security because the government has enough stockpiles of grains at warehouses of the state-run Food Corporation of India. Even in 2021, state reserves stood at 21.8 million tonnes of rice, against a requirement of 13.54 million tonnes. Companies that BQ Prime spoke to have told us about using damaged foodgrains as well. One can argue that in a utopian and efficient India, foodgrains won’t get damaged, and thus every ounce of crop produced will be utilised to address domestic hunger or for exporting to other countries. While that’s not where India is, the biofuel program may face more opposition elsewhere in the world than in India.

I would just like to end with a small observation around the market expectation of the RBI policy and the nuance around it. Remember, it was anyway widely expected that the RBI would remain front-loaded on rate hikes, after un-anchoring markets’ policy expectations in April and May.

“Inflation management is tricky as the real repo rate is deeply negative at -3.4% (4.4%-headline CPI at 7.8%). Thus, to arrive at a neutral real rate of 1% RBI will have to substantially increase the repo rate and tighten liquidity. Assuming that core inflation softens to 6% in the next 12 months the short term rates will have to be at 7% from the current level of ~4%”.

This comment was made by a keen watcher of macros and markets, and is evidence of the markets possibly pricing in an eventual repo rate of 7%. Does that suggest it is a little over-prepared for tightening? Any reprieve due to crude price correction prompted by a resolution to the war in Europe will be a positive surprise. Mind you, the smaller issues around supply chain management notwithstanding, the biggest bugbear remains crude, and thus, from an Indian perspective, it remains the key commodity to watch.

Niraj Shah is Markets Editor at BQ Prime.