Minimum Support Price and Inflation in India

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 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.

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Updated On : 5th Dec, 2018

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