Expect a 30-35bps hike in FY19 inflation and a hit in rice- and cotton-based exports as Indian prices rise above global ones.
Thanks to agri-GDP rising just 2.4% per annum in the NDA’s first four years versus 5.2% in the UPA’s last four years, and the lack of progress in reforming agriculture markets—to allow farmers to get a higher share of retail prices—the government was left with pretty much no option except to resort to a dramatic hike in minimum support prices (MSPs); more so since we’re in the run-up to the 2019 general elections. The hikes envisaged range from a high 12.9% for rice to 28.1% in the case of cotton and 52.5% in the case of ragi. The exact impact is difficult to judge as it depends upon how effective the MSPs are. In the past, hiking MSPs really helped farmers in only a few states like Punjab, Haryana, Madhya Pradesh and Chhattisgarh and, in the rest, prices of most crops remained far below the announced MSPs. This time around, the government has promised things will be different.
It is true that the second part of the MSP plan, where the government has promised it will pay the difference between market prices and MSP if it cannot procure, has not yet been announced because funding it is very expensive and the system can also be gamed in a big way—FE estimates it can cost Rs 175,000 crore if market prices fall by 20% below the MSP and Rs 260,000 crore if the prices fall by 30%. But, even without this, the government has promised it will try and procure a lot more than last year. Assuming the government is able to keep its promise, economists are penciling in a 60-70 bps hike in CPI inflation, or around half that in FY19, given it will come into play after half the year is over. With other pressure points like oil and a weak rupee, that is worrying as RBI will keep hiking rates if inflation looks like it is out of control. Depending on how soon the MSP-based deficiency plan is put in place, there will also be an impact on the fiscal deficit, unless the government is able to compress other spending.
More worrying, however, is the impact this will have on India’s exports and people employed in the sector. The biggest problem area is cotton where, after the MSP hike, Indian prices will be 24-25% higher than global ones. Given that two-thirds of all fibre used in India, for local use as well as exports, is cotton, this will impact not just exports of cotton fibre but also cotton-based textiles and readymade garments—how much is difficult to say, but FY18 exports of these items were over $19 billion. In the case of rice, the 12.9% hike in MSPs also makes Indian rice a bit more expensive than that from Vietnam, so some part of the $7.8 billon FY18 exports will take a hit.
It is for this reason that, apart from cajoling BJP-ruled states to work on reforming agriculture markets, the government would do well to consider extending unconditional cash transfers to farmers. This will cost about the same as a deficiency-payments system but, unlike that, will not distort prices; in other words, it will be less inflationary and won’t affect exports. But, since the scheme will make payments to land-owners rather than tenant-farmers, its political impact will be less. With less than a year to go before the elections, though, political impact is probably more on the government’s mind than economic rationale.