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Minimum Support Price and Inflation in India

S Mohanakumar (mohanakumar.s@gmail.com) teaches at and Premkumar (premkumar1914@gmail.com) is a research scholar at the Institute of Development Studies, Jaipur.

The Monetary Policy Committee of the Reserve Bank of India revised the policy rates upward consecutively for the second time in 2018. While revising the repo rates to 6.5%, the MPC placed the onus on the recently announced minimum support price for agricultural commodities, alleging that it might fi rm up rural demand and drive up the price level in the economy. But is this threat of price spiral due to MSP hike a reality?

The authors wish to thank the anonymous referee for valuable comments on the article.

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) hiked the policy rate by 25 basis points from 6.25% to 6.5% in August 2018 (RBI 2018a). Two such consecutive policy rate hikes have happened for the first time since 2013. The reverse repo rate, marginal standing facility rate and the bank rate have also been hiked along with the increase in policy rates. The MPC has justified the hike in repo rate by stating that an inflationary spiral had been on the anvil, and therefore, it was essential to contain the retail inflation rate within the desired range of 4±2%. Although the MPC deliberated on a handful of domestic and international factors likely to trigger inflation, in its press conference held immediately after the announcement of the repo rate hike on 1 August 2018, the committee, however, overemphasised the impending impact of the recently announced minimum support price (MSP) for kharif crops as the primary driver for the price spiral. This article examines the role of MSP in pushing up inflation in the economy.

The MPC meeting in August 2018 divulged that the performance of the domestic economy had been conditioned by a handful of factors in the domestic as well as the global economy. The factors identified in the domestic economy were: increase in input price for the industrial sector; implementation of the Seventh Pay Commission and subsequent uptick in house rent allowance (HRA) in various states; and revised MSP and its consequential effect on rural demand and the price spiral. Alongside, the MPC also noted that inflationary pressure and growth factors in the global economy such as monetary tightening in advanced as well as emerging market economies (EMEs); the growth performance of the world economy; uncertainties emerging out of the trade war spearheaded by the United States; and volatility in crude oil prices add onto inflationary pressures and influence macro fundamentals in India. Conversely, the MPC and the mainstream media focused more on the notified revision in MSP for kharif crops in July 2018 as the primary source and determinant of the anticipated spike in inflation in the economy, indicating that the RBI was left with little alternative, but to squeeze the liquidity by increasing the cost of borrowing through the repo rate and other policy instruments. Further, the MPC has argued that the hike in MSP would firm up the demand in rural India, driving up inflation beyond the comfortable band of 6%. However, it has also been emphasised that the RBI would stick to its declared neutral monetary stance (NMS), implying its adherence to the pursuance of the liberal economic framework.

Although the government notifies MSP for 23 crops in India covering 14 kharif crops, seven rabi crops and two calendar year season crops, in addition to fair price for sugar cane and jute, by and large, monopoly procurement has been limited to paddy and wheat in India for a fairly long time. Gulati (2018) estimated that 6% of the total produce of agricultural commodities was procured under the monopoly procurement system.

Table 1 (p 11) shows the trend in procurement of four major crops, namely paddy, wheat, mustard and cotton during 1996–97 to 2017–18. Paddy procured as percentage of its production varied between 16% and 36% with an average procurement of 28% during the last 22 years. The average quantity of wheat procured was 25.8% of its production and further, quantity procured as percentage of production of wheat widely fluctuated between 13% and 40% during 1996–97 to 2017–18. Cotton farmers were one of the worst hit in the crop production sector. The average quantity of cotton procured as percentage of its production was only 5%, barring two exceptional years, 2009 and 2015. There had been attempts to procure mustard in the early 2000s, but this was almost discontinued for a long time until 2015–16. On an average, only 4% of the total produce of mustard was procured during the period under reference. It is worth mentioning that mustard has been an important rabi crop in states like Rajasthan, Uttar Pradesh and Madhya Pradesh. The government stopped its procurement, notwithstanding the fact that the price volatility had driven the farmers into a deep crisis in major producing states, since the second half of 2000s.

Rajasthan accounts for more than 45% of area and production of mustard in India. A recent field visit to elicit the views of farmers on the monopoly procurement of mustard in Nahariya gram panchyat in Jaipur district in Rajasthan revealed that very few farmers sold their produce under the monopoly procurement system under MSP, even though the MSP was higher than the market price. According to a farmer from Nahariya ka Baas in Shivdaspura gram panchayat in Jaipur district in Rajasthan,

I cultivated wheat in the last rabi season in 40 bigha (kaccha land) and I sold 30 quintals of mustard in the market for₹ 3,800 per quintal albeit the MSP was₹ 4,000 per quintal. Farmers in our village opt to sell in the mandi (market) because of spot payment, whereas cash is credited in our account after three to four months under the monopoly procurement system. Another issue is the complicated procedures involved under MSP. I have to obtain jamabandi (landownership record) on area sown from the patwari (village revenue officer) and then, register online with the Rajasthan State Cooperative Marketing Federation. For a small farmer like me, the procedure is time consuming, cumbersome and not worth pursuing. Therefore, farmers in our village seldom sell mustard under MPS and wheat is not procured from our area. (Nandkishore Sharma, Nahariya ka Baas, Jaipur)

There has been widespread criticism that MSP announcements and effective interventions in the market for agricultural commodities remained mostly in government notifications and were seldom implemented. As is well known, MSP is a floor price to mitigate the price volatility-driven risk in farming and it provides an alternative avenue to the farmer to sell at the open market rate, if the market price rules above the MSP rates. The Committee on Doubling Farmers’ Income has estimated that the 14 major kharif crops have a profit margin (under MSP) less than 50% over the paid out cost plus imputed family labour cost (A2+FL). On the effectiveness of MSP, the NITI Aayog study is an eye-opener, as it reveals that only 10% of the farmers in India are aware of MSP before the sowing period. It has also been observed that in certain states, farmers are not even aware of the existence of MSP for their produce and further, 90% of the wheat procured under MSP is confined to three states, namely Punjab, Haryana and part of Uttar Pradesh. For other crops, to a great extent, the mono-poly procurement system has not yet been put in place or does not exist at all. Despite such limitations, MSP notifications and monopoly procurement limits, due to the free play of market forces for agricultural commodities, particularly during peak seasons, farmers are forced to be price takers with little bargaining power in the absence of state intervention in the market.

Traditional approaches to the supply response of agricultural commodities show the relationship between quantity supplied and price, while other determinants of supply of agricultural commodities are held constant. For long-run forecasting of agricultural commodities, often the duality relationship between production function and variable profit/cost function is employed to generate the supply response and input–demand functions. However, for the estimation of the supply response function for a subset of production in the short run, a simple one-stage estimation of Nerlovian models is adequate (Kumar et al 2010).

Price Elasticity of Supply

Price elasticity of supply of the four major crops covered under monopoly procurement is computed to measure the supply response in production to MSP. For computing price (MSP) elasticity of supply of paddy, wheat, cotton and mustard for the period 1997–98 to 2017–18 (up to 2015–16 for cotton and mustard), a variant of the Nerlovian double log model was used and the results are reported in Table 2. It was found that cotton had the highest supply elasticity with respect to MSP, followed by mustard. In the case of wheat and paddy, the response of production to MSP is 0.21 and 0.32 respectively, and the computed price elasticities of supply are in conformity with the findings of an earlier study (Kumar et al 2010). The price elasticity of supply shows that MSP plays an important role in the production of agricultural commodities and that its influence could be indirect as the MSP provides an alternative source for farmers to sell their produce.

The argument of the MPC that MSP would drive up the retail inflation rate in the economy can be statistically tested by estimating the correlation between MSP and retail inflation rate during 2005–06 to 2017–18. For kharif crops, the notified MSP in the current year would be effective from 1 October of the same year, and therefore, it is logical to presume that the effect of increased income with the farmers from sales proceeds through MSP and monopoly procurement would be reflected on the rural demand and inflation with a minimum lag of four months. The MSP of paddy and cotton in the current year is correlated with the quarterly inflation rate from 1 January in the next year. As paddy procurement is more decentralised as compared to wheat and other major crops, the impact of MSP on the rural demand and inflation would be more visible.

MSP and Inflation

The correlation between MSP and rate of inflation in the first quarter of the year (from 1 January to 31 March) was -0.207 for paddy and -0.128 for cotton. For wheat and mustard, the MSP is announced in October every year and procurement commences from 1 April as these crops are grown in the rabi season. Therefore, the MSP of wheat is correlated with the quarterly inflation rate commencing from 1 July (retail inflation rate in the third quarter) and the correlation coefficient for wheat was -0.340 for the period 2005–06 to 2016–17. In the case of mustard, the procurement is highly irregular and the quantity procured is insignificant to deduce anything from correlation coefficient for the period between 2005–06 and 2016–17. The correlation between MSP for the three major crops (excluding mustard) was considered in the analysis and the retail inflation rate was found to be statistically insignificant, and the observed trend broadly confirmed that there was no valid reason (statistically) to argue that the MSP for agricultural commodities had driven up inflation in India.

If increments in MSP were the primary driver of inflation, the rate hike could have been halted until the next scheduled meeting of the MPC in October 2018 as argued by one of its members, who did not agree to the hike in policy rate in August 2018. The logic for delaying the hike in policy rates is based on grounds that farmers often receive the proceeds from the monopoly procurement three to four months after sale. Moreover, inadequate infrastructure for procurement with the agencies of the governments prevents farmers from selling their produce immediately after the harvest, and this further delays the receipt of sale proceeds under MSP. The Indian experience suggests that the monetary policy would have an impact on output with a lag of 2–3 quarters and on inflation, a lag of 3–4 quarters (Acharya 2017). Dholakia was right in his argument that even if the anticipated spurt in rural demand triggered by the hike in MSP had occurred, as speculated by the MPC, the potential output could have been effectively managed by levelling it up to the spike in demand with a policy rate hike in October 2018 (RBI 2018b). Gulati had observed that unpaid Food Corporation of India (FCI) food subsidy bills had accumulated to a whopping sum of₹ 1.34 lakh crore over the years as on 31 March 2018 (Gulati 2018). The unpaid bills were eight times higher than the estimated additional burden of₹ 15,000 crore for procuring agricultural produce under the revised MSP in 2018. Is there any possibility of immediate payment this time? If there is no immediate payment, the revised MSP rate would not push up the price level as anticipated by the MPC. It is rather strange to note that policy rate hike became inevitable on account of the spike in MSP because the MPC had already started its deliberations on policy rate hike almost a month before the announcement of MSP. There were several factors that placed a higher upside risk on inflation in the economy, as core CPI inflation had reached 6.4% in June 2018 under the influence of global factors and volatility in crude oil prices. The policy rate hike can be qualified as a Pavlovian response in the light of such hard facts and figures.

The repo rate is connected to other rates in the financial markets and a hike in the former amounts to tightening liquidity in the money market. The hike in repo rate could be consequential as it would push up the cost of borrowing in formal as well as informal money markets. Farmers and petty commodity producers depend more on the informal credit market (non-institutional sources), particularly in rural India, for reasons sufficiently documented in the literature. Incidence of indebtedness of rural households showed that borrowing from non-institutional sources is significantly higher in the lowest deciles of the population defined in terms of asset holdings. It is found that 72% of indebted rural households in the lowest four deciles resort to non-institutional sources for credit. The Spearman rank correlation showed a positive and significant (0.0988**) relationship between size of asset holdings and incidence of indebtedness from institutional sources of rural households in India (NSSO 2014). It is worth mentioning here that 89% of institutional credit is disbursed for a rate of interest of less than or equal to 15%, whereas 74% of the credit doled out from non-institutional sources attracts an annual rate of interest of more than 15% (NSSO 2014). Two consecutive hikes in policy rates indicated that the RBI had indirectly pushed the cost of credit, and thereby, the supply price of agricultural commodities in India. The total effect of such a spike in policy rate would be the pushing up of the supply price of farm produce, which has already been thrown into the state-managed crisis for the last two decades. Further, spike in cost of borrowing could neutralise the likely monetary gains from the announced hike in MSP.

The MPC observed that the NMS of the RBI would be adhered to and it meant that the future policy rate hike could be paused or reversed, if global financial uncertainties were cleared. It has also been acknowledged that leakages of global inflation to the domestic economy facilitated by monetary reforms have weakened the link between monetary aggregates and inflation in India. The RBI has estimated that a 10% depreciation of the domestic currency would drive inflation up by 0.5%. Ghosh et al (2017) argued that “there is a significant impact of global uncertainty on the monetary policy of India.” Leakages of global inflation to the Indian economy would sound a better reason for expected inflation because of eruption of global financial uncertainties in the backdrop of the Fed rate hike, trade wars and expected currency war. Unfortunately, none of the factors in the changing global macroeconomic scenario and its linkages with domestic money market outcomes were highlighted in the press conference of the MPC or the mainstream media in India.

Overemphasis on MSP amounts to cascading the monetary management system into a narrow groove of the market liberalism, ignoring the hardships and reproduction crisis that farmer and agricultural labourers, who account for about half of the workforce in India, have been undergoing for the last quarter of a century. Ever since the introduction of the neo-liberal regime in India in 1991, the protagonists of market reforms have also argued for doing away with MSP as it distorts the market for agricultural commodities. The neo-liberal market framework objects to the use of MSP because liberalism demands the state’s absolute non-intervention in the market for small producers and the MPC also shared the same anti-farmer stance.

Conclusions

The MPC of the RBI revised upward the policy rates consecutively for the second time in 2018, but the policy rate hikes were not in conformity with the ground macroeconomic realities in India. Moreover, the role and functions of the RBI have been narrowed down to a single-point agenda of regulating inflation within the desired range as warranted by the NMS embedded in the flexible inflation targeting (FIT) regime. The FIT monetary regime is known for its plutocratic bias. While revising the repo rates to 6.5%, the MPC placed the onus on the recently announced MSP for agricultural commodities, alleging that it might firm up rural demand and drives up the price level in the economy. Although the government announces MSP every year, farmers are often dissuaded from availing monopoly procurement system primarily on account of its inbuilt labyrinth-like structure and procedures. In effect, the standpoint of the MPC on MSP is in conformity with the neo-liberal arguments for withdrawing state support system to the petty commodity producer in India. The present monetary regime and the hike in repo rates amounted to tightening liquidity and it may push up the cost of production, eventually driving out small producers, including farmers from their traditional occupation. It would not only neutralise the effect of the revision in MSP, but aggravate the crisis of agricultural and allied sectors and small producers in the non-agricultural segments.

References

Acharya, Viral V (2017): “Monetary Transmission in India: Why Is It Important and Why Hasn’t It Worked Well?,” Inaugural Aveek Guha Memorial Lecture, Tata Institute of Fundamental Research (TIFR), viewed on 30 November 2017, https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=1049.

Dalwai, A (2017): Report of the Committee on Doubling Farmers Income, Vol 4, p 90, Department of Agriculture, Cooperation and Farmers’ Welfare, Ministry of Agriculture & Farmers’ Welfare, New Delhi, http://farmer.gov.in/imagedefault/DFI/DFI%20Volume%204.pdf.

Ghosh, Taniya, Sohini Sahu and Siddhartha Chattopadhyay (2017): “Households’ Inflation Expectations in India: Role of Economic Policy Uncertainty and Global Financial Uncertainty Spill-over,” IGIDR Working Paper, WP-2017-007, http://www.igidr.ac.in/pdf/publication/WP-2017-007.pdf.

Gulati, Ashok (2018): “From Plate to Plough: Four Years of Neglecting Farmers,” 13 May, viewed on 7 August 2018, https://indianexpress.com/article/opinion/columns/farmers-distress-agriculture-sector-rural-economy-narendra-modi-govt-bjp-manifesto-subsidy-5159086/.

Kumar, Praduman et al (2010): “Factor Demand, Output Supply Elasticies and Supply Projections for Major Crops of India,” Agricultural Economics Research Review, Vol 23, January–June, pp 1–14.

NSSO (2014): “All India Debt and Investment Survey,” 70th Round, January–December 2013.

RBI (2018a): Third Bi-monthly Monetary Policy Statement Meeting, 2018–19 Resolution of the Monetary Policy Committee (MPC), Reserve Bank of India, 16 August, viewed on 16 August 2018, https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=44636.

— (2018b): Minutes of the Monetary Policy Committee Meeting, 30 July and 1 August, viewed on 16 August 2018, https://www.rbi.org.in/Scripts/BS_Press Release Display.aspxprid=44767.

Updated On : 5th Dec, 2018

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