The central bank had spoken of a persistent upside risk to inflation while it grudgingly opted for easing action last month and warned about limited room for further easing.
During the last Five-year Plan through the 2011-12 fiscal, the government had raised the minimum support price (MSP) of crops in the range of 29% to 107%, and while this has boosted rural income and purchasing power, the higher MSPs also contributed to inflation.
The CACP has recommended that paddy price be raised by 15.7% to R1,250 per quintal, jowar by 53% to R1,500, maize by 20% to R1,175, moong by 28.6% to R4,500, urad by 30% to R4,300, tur by 25% to R4,000, groundnut by 37% to R3,700 and soyabean by 33% to R2,200.
Trade executives say that if grain prices remain subdued due to adequate stocks and a good harvest, the government will be forced to procure more from farmers to avoid distress sales, exacerbating its subsidy bill. Farmers are opposed to the paltry hike in prices, saying they dont cover even the cost of production due to a spike in inputs costs and labour.
The hike in MSPs holds the key to any flare-up of food inflation, said CARE Ratings chief economist Madan Sabnavis.
Headline inflation showed signs of moderation since December and stayed at 6.89% in March after tripping 9% in the first 11 months of 2011, although analysts attributed the fall mostly to a high base last year. High food inflation, a major driver of headline inflation, remained high until recently since a drought in 2009 shrank the summer harvest.
Factoring in persisting upside risks to inflation, the RBI last month warned about limited scope for further monetary easing after pruning the repo rate after three years by a sharper-than-expected 50 basis points to 8% to prop up a faltering economy.
Although the main reason for the cut was lower-than-expected core inflation of 4.7% in March, analysts said any spurt in food inflation will only prompt a hawkish RBI to harden its stance, especially in view of uncertainties about crude oil prices.
Ringing the warning bell, global rating agency Standard & Poor's late last month cut India's outlook to negative from stable, and cautioned that inflation might not fall significantly due to structural issues.
The positive sentiments after the forecast of a normal monsoon for 2012 may be spoilt by the substantial hike in the MSPs. But another problem is if market prices of rice continue to remain subdued, the government will be forced to go in for massive procurement at higher prices. This will raise the food subsidy bill, said a senior executive at a multinational trading company.
A senior official admitted that the jump in paddy prices may have significant bearings on governments food subsidy, especially if it decides to implement the proposed Food Security Act. Retail prices of pulses and oilseeds wont flare up because they are already much higher than MSPs, he added.
Already, the government is struggling to accommodate fresh crops in its almost-choked warehouses. Officials are jittery that if the government is forced to offload stocks by raising allocation to states or by offering to bulk consumers at cheaper rates, its subsidy bill will shoot up.
The government's food subsidy bill is estimated to rise marginally to Rs 75,000 crore in the current fiscal from Rs 72,823 crore in 2011-12.
However, farmers are not impressed with the hike in MSPs. The cost of production is at least 30% more than what the government has estimated, according to Krishan Bir Chaudhary, chairman of the Bharat Krishak Samaj.
During the five years through 2011-12, the price of paddy has been raised by 45%, wheat by 29%, maize 58%, tur 107% and moong 101%. Similarly, the benchmark rate of soyabean has been hiked by 61%, mustard 39%, sugarcane 78.6% and cotton 55.6%.
However, even by the estimate of agriculture minister Sharad Pawar, the cost of pesticide has escalated by nearly 150%, seeds by 75%, fertiliser especially urea by 60% and diesel by nearly 75% over the past couple of years. Added to this is the extremely high cost of labour on account of MNREGA. For the government's MSP to cover all these costs is well high impossible, Pawar wrote in a letter to Prime Minister Manmohan Singh in April while pitching for removing curbs on exports of farm items.