Cost-push inflation: The new MSPs’ inflationary pinch

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New Delhi | Published: July 6, 2018 4:22:03 AM

The Technical impact of 2018-19 kharif MSP hikes on CPI inflation is estimated at 110 bps. the actual rise will depend on demand-supply conditions.

agriculture sector, cropThe wholesale prices are for the edible version of the crop, whereas the MSPs apply to the raw crop that is brought to the mandis for procurement. (Reuters)

The Union Cabinet cleared 2018-19 kharif Minimum Support Prices (MSP), with increases in line with the earlier Budget commitment to set MSPs at 1.5 times the cost of production. This commitment has been met in full (and even more) for FY19, with a significant jump in procurement prices set for FY18 kharif season. The rise in the support prices of the covered crops is significantly higher than in previous years, with the composite index for FY19 kharif crop MSPs up 16.9%, compared to an average of 4% over FY14–FY18. The last time we had seen increases of this magnitude was in FY12 and FY13, with kharif MSPs rising 11.8% and 24.6% respectively. In FY19, the Commission on Agricultural Costs and Prices estimated that costs (calculated on an A2 + FL basis) have risen in a range of 0 to 8%, with a mean increase of 5%.

The first point to emphasise is that this hike in MSPs was required, given the current adverse conditions of prices and operating conditions of the farm sector, and is a key component of the prime minister’s goal of doubling farm incomes by 2022, which, in itself, is a must for sustaining a 8–9% GDP growth for India. However, MSP increases are, largely, a short-term fix and must be viewed in conjunction with other legs of the strategy. If the other components of the strategy are not implemented with urgency, the associated macroeconomic costs will be a significant drag on overall economic growth.

The immediate cost is that the hike will prima facie likely have significant food inflation effects, reversing the trend of food inflation having fallen steadily from 11.8% in FY13 to 1.8% in FY18. Consequently, together with the nudging of an inflation-targeting monetary policy, headline CPI inflation had also come down from 10.2% in FY13 to 3.6% in FY18.

Technically speaking, applying the latest MSP hikes to the CPI index for March 2018, the headline inflation number would have risen by 1.10 percentage points (i.e., instead of the then reported 4.3% print, the probable inflation rate would have been 5.4%). Abstaining from secondary impacts on inflation of the higher farm incomes from the higher procurement prices, expected CPI inflation for FY19 might rise from the currently forecasted average of 4.4% to 5.5%.

But, this is a hypothetical premise, based on applying the rise in MSPs to the weights of the corresponding produce in the CPI basket. While past trends definitely do support this inference, market price dynamics are much more complex, including demand-supply gaps, the extent of procurement, transfers to farmers through price deficiency support payments, and changes in relative discretionary incomes of the urban and rural segments. One potential inflation mitigating factor in these dynamics, however, which commentators have pointed to, deserves analysis: that wholesale market prices (let alone retail prices) of many of these crops have been higher than the respective MSPs, mitigating the impact of the MSP increases. There are 2 caveats to this line of thought:-

First, the wholesale prices are for the edible version of the crop, whereas the MSPs apply to the raw crop that is brought to the mandis for procurement. For example, the MSP applies to the paddy crop (dhaan in hindi), whereas the wholesale prices apply to the rice which we eat. In many instances, the mandi procurement prices (of the raw crop) remain below the MSP, even though the wholesale prices (of the processed grains) are above. Wholesale price of paddy (the raw husked crop) in January ‘18 was `19.89 per kg, while that of rice was `30.03 per kg (downloaded from Note that both are wholesale prices, one for the raw crop procured at the mandis, the other of a processed variety sold from the mandis to traders. One exception in FY18, however, was that even wholesale prices of pulses had dropped below the MSP. However, MSP procurement of pulses was a low 8% of total produce in FY17, so the bulk of the produce was sold much below the MSP.

Second, trends in MSPs vs prices of processed produce suggest that rising MSPs do indeed, for the most part, push wholesale prices up. While there is certainly a role of the demand and supply situation in price formation, the trends of wholesale prices of rice, jowar, bajra and most edible oils since FY15 support this view. Once again, the exception was the price of pulses, where, after a massive surge in prices in FY16, higher production led to a steep drop in prices in FY17 and a slide below its MSP in FY18.

While the MSP increases are likely to push food inflation up, there will be also be a fiscal impact of the hikes. There is a trade-off between inflation and fiscal slippage, depending on the extent to which the procured crops are sold on the open market rather than through the public distribution system (PDS). Too little is known about the Centre’s plans to implement its price and income support schemes for us to make informed guesses on the fiscal costs. These fiscal costs are also likely to have tertiary effects on inflation.

Vikram Chhabra and Abhay Chavan contributed to the article.

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