Are Indian agricultural prices co-integrated with global prices?

• Indian agricultural prices are not co-integrated with global agricultural prices in short run.
• Existing literature shows that our markets are not efficient, and thus they cannot respond to sudden shocks.
• Degree of openness data suggests that Indian agriculture sector has started opening up, but this is not visible in market integration for agricultural commodities.
• One major reason for asymmetric price transmission is NTBs across countries. Non-product specific support has posed greater problems for India from the market efficiency point of view.

The agricultural sector in India is progressively opening up to external trade, leading to interdependency between commodity prices across diverse markets. The correlation between global and domestic prices of agricultural commodities and changes therein depend upon many factors in accordance with the demand and supply conditions.

The main factors that affect commodity demand and hence prices at the global level are changes in exchange rate, nation’s purchasing power and interventionist policies such as taxation or subsidies followed by the trading countries. It also depends on regional trade agreements, because they create blocks of different trading countries, hence leading to trade diversion and trade creation.

On the other hand, changes in farm prices at the national level are also influenced by demand and supply conditions in global and domestic markets, domestic support, tariffs and non-tariff barriers, infrastructure and other government policies. Trade and exchange rate liberalisation is expected to affect domestic prices, partly due to globalization of the economy and partly due to removal of administered pricing and trade restrictions.

A greater interdependency between products prices across spatial markets is an indicator of market efficiency. A perfect price transmission, among many factors, provides signals to producers for good allocation of resources, to expand production base and become globally competitive. In spatial terms, the classical prototype of the Law of one Price, as well as the predictions on market integration provided by the standard spatial price determination models postulate that price transmission is complete with equilibrium prices of a commodity sold on competitive foreign and domestic markets; differing only by transfer costs, when converted to a common currency.

These models predict that changes in supply and demand conditions in one market will affect trade and therefore prices in other markets as equilibrium is restored through spatial arbitrage. The absence of market integration or of complete pass-through of price changes from one market to another has important implications for economic welfare. Incomplete price transmission arising either due to trade and other policies, or due to transaction costs such as poor transport and communication infrastructure result in a reduction in price information available to economic agents and consequently may lead to decisions that contribute to inefficient outcomes.

For the most part, literature points out that in developing countries, implementation of liberal macroeconomic policies may not be sufficient to ensure a higher responsiveness of their domestic prices to world prices. WTO negotiations on AOA (agreement on agriculture) are still continuing with respect to tariff rates. In theory, spatial price determination models suggest that if two markets are linked by trade in a free market regime, excess demand or supply shocks in one market will have an equal impact on price in both markets, which is missing in the Indian scenario.

The Johansen test (Statistic) for co-integration for rice, wheat, maize, soybean and cotton shows no short run co-integration (five-year period from 2014-2018). For each commodity, values of co-integration are coming to less than the 5% of critical value (means 95% of confidence). According to these results, it is clear that from 2014 till March 2018, domestic prices are not cointegrated in the short run as suggested by Johansen cointegration test. The entire statistic is coming out to be insignificant in the ECM (error correction mechanism) model.

Hence it can be said that if Johansen cointegration test suggests that there is no co-integration in the short run, ECM will give insignificant test statistic. According to the existing literature it can be said that our markets are not efficient and thus cannot respond to sudden shocks. CATR analysis indicates the same direction that current literature on Indian market integration suggests. Many notable economists have empirically tested integration of Indian market and concluded that there is no co-integration of the domestic and world markets.

Correlogram of original and first difference prices for five commodities.

Source: CATR Estimation using IMF dataset

Correlogram for World wheat price which shows non-stationarity.

Source: CATR Estimation using IMF dataset

Correlogram of first difference of log of World wheat price which shows stationarity.

Why Indian Agriculture Market Is Not Cointegrated?

According to Sudha Narayanan, the subsidies under the green box are continuously rising for rice and wheat. Also, our wheat prices are higher than global wheat prices because of higher MSP (minimum support price). Agreement on Agriculture (AoA) says that for developing nations, the combined output and input support needs to be maintained within 10% of the value of production. Support price of wheat with moving external reference price is rising for India since 2004. One of the reasons for asymmetric price transmission is non-tariff barriers (NTBs).

Non-product specific support, ie, input subsidies on fertilizer and electricity to agriculture has posed a greater problem for India from the market efficiency point of view. All domestic support measures considered to distort production and trade fall into the amber box. These include measures to support prices, or subsidies directly related to production quantities. Any support that would normally be in the amber box is placed in the blue box if the support also requires farmers to limit production. Due to differentiation in standards and quality of products, many indigenous commodities may not be substituted for the same products of other nation.

Degree of openness suggests that Indian agriculture sector has started opening up in a calculated manner by using price differential and import penetration method but this opening is not reflected in market integration for agricultural commodities. Other nations also keep their agricultural sector well protected because it is a highly sensitive sector for any economy. Because of restricted trade in agriculture and high domestic support which distorts the trade, there is no short run cointegration between Indian and world agricultural prices.

According to the mandate of Commission for Agricultural Costs and Prices, the government needs to provide incentives to producers for adopting improved technology and developing a production pattern broadly in the light of national requirements. They regularly administer prices for agricultural goods, which is a daunting parameter for co-integration.

No doubt, most developing and developed countries are providing the cushion, but slowly and gradually, we have to open this window. The Commission may also suggest non-price measures related to credit policy, crop and income insurance, capacity building and other areas, as it would facilitate in integrating domestic prices with global prices.