Politics of Minimum Support Price & Inflation in India

June 27, 2014 · Author: · Category: market 

Minimum Support Prices (MSPs) of Agricultural commodities (summer crop) has been raised by a weighted average1 of 2.1% y-o-y, from 5.6% in FY14 and 24% in FY13. This is in line with the Commission for Agricultural Costs and Prices (CACP)’s recommendations. Specifically, the key MSP changes are as follows – a 4% rise for rice, 1.6% for coarse cereals, 1-2% for pulses and 0-2% for oilseeds.

A lower rise in MSP, if implemented, would be a medium-term positive for lowering the inflationary impulses in the economy, as MSPs form a floor on food prices. In the past, rising MSPs (along with other factors) led to higher food prices and CPI inflation, which in turn fed into higher rural wage inflation (as rural wages were indexed to CPI inflation). Therefore, there is a need to keep MSPs in check. We estimate that a 3.5 percentage point drop in the weighted average MSP price increase (5.6 to 2.1) would lower headline CPI inflation by 30-40bp over the subsequent four quarters, all else equal. This could help partly offset the negative impact on CPI inflation from the anticipated increase in food prices due to both the drought and the release of suppressed freight and fuel prices. Currently, CPI inflation is on track to meet the RBI?s first glide path target of 8% CPI inflation by January 2015, in our view.

We estimate that a 3.5pp drop in the weighted average MSP price increase (5.6% to 2.1%) will lower headline CPI inflation by 30-40bp in the subsequent four quarters, all else being equal, partly offsetting the negative impact on CPI inflation from other factors such as bad monsoons.

Till June 18, the monsoon has been ~42% below the normal with scanty to deficient rainfall across India. Monsoon arrival has also been delayed, which has affected the crop sowing. While the weak monsoon may be mitigated through the healthy reservoir levels, the risks remain. The effect of the measures to restrict essential commodities prices (announced on June 17) will take time to yield result and in some cases may have limited effect.

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