Kharif MSP To Increase Wholesale Inflation By 38bp And Retail Inflation By 70bp

The hike in minimum support price (MSP) of kharif crops for the 2018-2019 season will impact wholesale inflation by 38bp yoy and retail inflation by 70bp yoy, estimates India Ratings and Research (Ind-Ra)

Manageable Impact on Food Inflation: While the first round of impact on wholesale inflation is estimated to be 38bp, the impact on foodgrain inflation is likely to be lower at 19bp, half of the overall impact. Since the wholesale foodgrain inflation in the last 13 months has been negative, the impact of MSP increase is unlikely to translate into positive inflation. However, the impact on retail foodgrain inflation is estimated to be higher at 28bp.

Concerns for Farmers without Marketable Surplus: While ensuring 50% return over the cost of cultivation is likely to reduce some agri distress, this would largely benefit the farmers with a marketable surplus. According to agriculture census 2010-2011, 67.1% agricultural land holding belongs to small farmers (operational holding size below 1.0 hectare) and another 17.9% to small farmers (1.0-2.0 hectare). These farmers generally do not have a much marketable surplus.

Large Variations in MSP Increase: The MSP increase announced is not uniform across the 14 kharif crops. Although the government has promised to fix the MSP 50% higher than the cost of production, crops such as Bajra, Arhar and Urad were already providing more than 50% returns over the cost of cultivation to farmers in 2017-2018. The cost of cultivation includes all paid out costs such as those incurred on account of hired human labour, bullock labour/machine labour, rent paid for leased in land, expenses incurred on use of material inputs such as seeds, fertilisers, manure, irrigation charges, depreciation on implements and farm miscellaneous expenses, and imputed value of family labour. The increase in MSP in the 2018-2019 season over 2017-2018’s varies from a low of 3.7% for Urad (65.39% return in 2017-2018) to 52.5% for Ragi (2.10% return in 2017-2018).

Impact on Monetary Policy: This expected rise in MSP has been on the radar of the Reserve Bank of India and it had flagged this as a concern since the government announced the FY19 budget. As mentioned above, the impact of the rise in kharif MSP alone has the potential of increasing retail inflation by 70bp, in conjunction with elevated oil prices and depreciating currency it can destabilise a number of macroeconomic variables and financial arithmetic of the government and the corporate world. Therefore, Ind-Ra expects that even after considering a positive impact of monsoons on food inflation, the inflation trajectory in the near term would remain upwardly biased and hence at least one more rate hike by the regulator is likely, more so in October 2018, though a rate hike in August 2018 cannot be entirely ruled out.

Impact on Fiscal Deficit: Ind-Ra believes the higher MSP would certainly affect the fiscal arithmetic, but in case goods and services tax collections remain buoyant as was witnessed in May 2018, it will offset some of the adverse impact of the MSP increase on fiscal deficit.

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About the Author

Dr Devendra Pant
Chief Economist and Head Public Finance, India Ratings and Research (Ind-Ra)