Modest MSP hike is a tightrope act by govt
MSPs for kharif season are the highest in the last five years, but lower than prior pre-general election years, underlining the Centre’s careful balancing act
Concerns over sluggish rural demand in a pre-election year, and the risks of disruption to agricultural output from El Nino-driven drought-like conditions, put the spotlight on the quantum of increase in the government’s announcement of the Minimum Support Price (MSP) at which it will procure crops from farmers for the 2023-24 kharif season. This became especially important because the government needed to find a delicate balance between supporting rural incomes and not accentuating inflationary pressures. It turns out that weighing the crops by their share in the Consumer Price Index (CPI), the weighted average increase in MSP for 2023-24 kharif crops is around 7%. The increase varies in the range of 5-10%, with MSP increase higher (around 10%) for some pulses and cash crops. To recall, the extent of crop procurement by the government at MSP is limited to a few crops and dominated by a few states. Nevertheless, MSP is a safety net that protects farmers in case of a drop in crop prices and often acts as a guidepost for prices in open markets.
The burning question is how to think about the degree of MSP increase, and where it stands vis-à-vis meeting the twin objectives of boosting rural incomes but not being inflationary. The quantum of MSP increase in 2023-24 could be analysed through different lenses, leading to somewhat divergent conclusions.
Firstly, from a historical perspective, the 7% weighted average increase in 2023-24 is the highest in the last five years and the second highest in the last decade. However, if we compare with the large spikes in MSP seen in pre-general election years, then the 7% increase is dwarfed by the 34.1%, 19.6% and 15.2% witnessed in the last three pre-general election years.
Second, even from the prevailing inflation perspective, the MSP increase seems quite modest. CPI inflation for the cereal subgroup stood at 12.7% YY in May 2023. Third, from the perspective of farmers’ income, this MSP hike could just about neutralise the increase in cost of production. Wholesale prices of different raw materials and wage data suggests that farmer input prices would have gone up by 6.5-7.0% over the last year. The terms of trade most likely would have worsened last year, as the kharif crop MSP increase was lower than the input price inflation, as per our estimate.
Fourth, for most of the crops, the actual market price might be close to the announced MSP, and hence a large catch-up might not be required for market prices to adjust. So, in a nutshell, the MSP increase seems to be adequate but falls short of being an explicit pre-election rural stimulus.
In terms of macro implications, the near-term impact of MSP could be visible on inflation, rural demand, fiscal policy and monetary policy. We think that the impact of MSP increase on consumer price inflation would be relatively subdued. To some extent, a more modest increase in MSP might help offset any possible upside inflation risk from a delayed start to monsoon and El Niñoconditions. Reserve Bank of India (RBI) estimated a 10-12 basis point upside risk to its inflation forecast (5.1%YY for FY24) from the MSP hike. However, we think that there could already be some buffer in the central bank’s conservative inflation forecast and it is unlikely to be revised upwards if the monsoon remains around normal levels. Moreover, recently procured wheat crops could be sold by the government in the open market to further bring down cereal inflation.
The impact on rural demand is more difficult to quantify as it would be impacted by multiple other factors. A higher MSP alone is not adequate to remove all the headwinds facing the rural economy. Consumption growth trends in recently released Gross Domestic Product (GDP) data have been weak, with momentum in drivers of rural consumption remaining uneven.
While this MSP increase could cover the cost of production for farmers, it might not be large enough to prompt an immediate fillip to rural consumption. The hopes in the financial market about a pre-election fiscal boost for rural consumption will have to wait a bit longer. In theory though, any populist fiscal spending could still be planned closer to the general election date, to magnify the announcement effect.
Lastly, the extent of MSP increase is not large enough to materially alter the estimate of food subsidy in the Union Budget. The upside pressure on subsidy bills could come more from fertilisers, where the government has been indicating about the possibility of ₹50,000 crore additional spend. The impact on monetary policy is likely to be quite favourable as it could comfort RBI that there are no curveballs from MSP on the otherwise downward trajectory of inflation. This is important against the backdrop of RBI’s keenness in achieving its target of 4% headline inflation, as the economy has normalised from the impact of multiple shocks. A larger MSP hike could have derailed this process again.
Samiran Chakraborty is managing director and economist, India, Citigroup. Baqar Zaidi is economist, Citigroup. The views expressed are personal
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