Minimum Support Price (MSP) is a form of market intervention by the Government of India to insure agricultural producers against any sharp fall in farm prices. MSP is price fixed by Government of India to protect the producer – farmers – against excessive fall in price during bumper production years. The major objectives are to support the farmers from distress sales and to procure food grains for public distribution. No doubt, the demonetisation suppressed the pricing powers of the farmers in a year of a bumper crop and there has been rural distress thereafter and farmers have been demanding higher MSPs to offset the losses in last two crop years. Reformist prime minister Narendra Modi had refrained from raising MSPs at the brisk pace as seen during UPA rea but now the government faces 2019 election hurdle which necessitated a major overhauling of MSPs of Kharif crops for the next season.
The government on Wednesday approved steep MSP hikes of up to 52% for 15 crops, which is expected to cost the exchequer about Rs 15,000 crore. MSP for one of the most significant Kharif crops, paddy, has been increased by Rs 200 per quintal to Rs 1,750 per quintal. The decision to hike the minimum support price (MSP) for kharif crops comes with the broader aim to inch closer to the Prime Minister’s promise of doubling farmers’ income by 2022 and provide at least 50% return on the farming costs as envisaged in the last budget. The current set of increase is the highest ever single-year raise which is likely to create major price distortions for these crops.

Whether farmers will receive an adequate price for their produce-will only be ascertained after the harvest. However, experts have pointed out that the move may stoke inflation, prompt the Reserve Bank of India (RBI) to hike interest rate, as well as widen fiscal deficit. While India Ratings predicts wholesale inflation may rise by 38 bps year-on-year and retail inflation by 70 bps, Yes Bank says the MSP for Kharif crop is expected to add 35 bps incrementally to headline inflation in the current financial year and the direct impact of MSP hikes in CPI inflation is estimated to add around 70 bps over a 12 month period.

In June’s bi-monthly monetary policy, Deputy Reserve Bank of India (RBI) Governor Viral Acharya had warned that any upward pressure on food prices and that generous MSPs can exacerbate headline inflation pressures. India’s retail inflation grew 4.87% in May, a four-month high, from April’s 4.58%, driven by costlier fuel. The rate of change in price rise, which almost touched 5% is inching towards the apex bank’s upper tolerance level of inflation at 6%. Last month, the central bank had raised the repo rate by 25 bps to 6.25% for the first time since January 2014. However, MSP hike is not expected to accentuate RBI’s concerns on inflation but a larger risk could emanate from elevated crude oil prices which are a function of supply side dynamics.

The fiscal cost of the MSP schemes would depend on the type of scheme that is finally implemented by the government. For instance, under the Market Assurance Scheme the quantum procured by the government would be critical and under the Bhaavantar scheme, the compensation limit and the quantum for which the compensation is provided will determine the cost to the government. The higher MSP would certainly affect the fiscal arithmetic. However, if tax mop-up from goods and services tax (GST) remain buoyant as it was in May 2018 (Rs 94,016 crore), it will offset some of the adverse impacts of the rise in floor price increase on fiscal deficit.

The 12-crore strong farmers’ lobby has been at the receiving end ever since demonetisation led to the crash of their income and there have been widespread protests against the government in different parts of the country. This hike is nothing but to assuage their grievances so that they don’t turn up the heat against the government in upcoming Assembly polls in three crucial states and the general election next summer.

However, MSP is a tool of the socialist era and not the right mechanism to assuage the farmers’ grievances. The government must try to build markets for farmers produce by freeing them from the hands of brokers by dismantling the APMC. The export market must be opened around the year to have a better pricing for farmer’s produce. The need is to rationalise different subsidies for the farmers. The government must envisage a mechanism to provide direct benefit transfers for the cost of inputs on the basis of per acre basis. The crop insurance scheme must be provided universally so that farmers don’t face hardships during a natural disaster. And the capital expenditure must be raised substantially so that irrigation facilities reach to every acre of the farmland.