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Spike in MSPs a lagged intervention to ameliorate farm distress

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Mr.Dhananjay Sinha

Head of Research, Economist & Strategist

25 Jul 2018

The government’s acceptance of Minimum Support Prices (MSP) for the kharif season (for 13 summer crops;average hike of 15%) marks the highest increase since 2013. Importantly, it reflects a lagged intervention by the government to ameliorate the long-standing farm sector distress arising from declining net realizations, especially in the aftermath of demonetization. While Paddy has seen a hike of 13%, MSPs for Coarse Cereals (35%), Oil Seeds (17%) and Cotton (27%) have seen a much higher increase.

The prolonged rural distress can be seen in the nominal Agri sector GVA growth of 4.5% in FY18, which is the lowest growth since FY04. As per our calculations, the terms of trade for the Agri sector have declined by 8.5% since its peak in FY11, 30% of which occurred post the demonetization shock. Terms of trade captures the realized price for the farm sector produce relative to the cost index and hence it is a reliable indicator of its profitability.

Delay in the MSP announcement and weak farm sector realizations of the past have possibly led to the 21.6% yoy decline in Kharif crop sowing till date at 165.2 lakh hectares. Hence, potential lower post-harvest supply, aggressive procurement by the government and higher MSPs may lead to better realizations for the farmers going forward.

Our estimates indicate that even with the average increase of 14.5% in MSP, the average MSP will fall short of the government’s promise of ensuring MSP of 50% above the comprehensive cost of cultivation. Official claims that the MSPs reflect the promised 50% margin over the cost of cultivation are possibly based on A2+FL estimates of cost of cultivation (basic cost of inputs paid + family labor). However, if we take a more comprehensive measure, C2, which also includes imputed cost of land, financial cost etc, the average margin from Kharif MSPs works out to just 15.4%.

Therefore, while the promise of doubling the real farm income by 2022 looks difficult, the MSP announcement still represents a precursor to similar steep MSP hikes ahead of the 2019 general election and several major state elections.

We also observe that the government has stepped up the procurement of foodgrains, including Rice, Wheat and Coarse Grains, with the outstanding buffer standing at 73.3mt in May’18 (up 17% yoy). It is also higher than the previous peak of 72mt in 2012.

So, clearly, by restraining market supplies, the government is striving to ensure that MSPs are also effective in impacting realized prices for the farmers, including in several states where government procurement is not so effective. Indeed, mandi prices for Wheat and Paddy in states such as Odisha, West Bengal and Bihar(which had earlier traded lower than MSPs) are currently close to MSPs or higher.

The other aspect that will need to be considered, in case of Paddy in particular, is that the steep rise in MSP will lift the Paddy price above the import price. For instance, at Rs1,750/quintal, the price of rice works out to Rs26.6/kg. 

The comparable Thailand export price, which has moderated in recent months, is somewhat lower at Rs25.5/kg. Hence, inclusive of other logistic costs, the domestic market price for base quality rice at ~Rs29-30/kg will make domestic suppliers uncompetitive. This will call for trade protection by way of higher minimum import prices, or else, the government may end up buying a much higher quantity. With Food Corporation of India’s storage capacity already utilized to the extent of 76% of 36.3mt by March end and total stock in the central pool now standing at 73.3mt, higher MSP relative to global prices can accentuate the storage space constraints.

Against this backdrop, a key question that needs to be answered is: Will increase in MSPs help resurrect farm sector entirely? In the best case scenario, it will only partially alleviate the pain in the agri sector.

The proportion of horticulture segment at 52% (~300mt), mainly Fruits & Vegetables, in the total farm produce has surpassed the Cereal segment (~280mt) since 2012-13. MSP hikes are not relevant here. Hence, the weaker terms of trade of the horticulture segment may still take more time to recuperate. Also, for the foodgrain segment, the recovery in terms of trade may be gradual, as the effectiveness of MSP is stronger only in Cereals, as thegovernment agencies mainly procure mostly Wheat and Paddy.   

Given the limitations of policy interventions in the farm sector, the government appears to be working towards a broader theme for uplifting the rural economy (not just farm incomes), including higher rural sector Budget allocations (MNREGA, rural housing and infrastructure), farm loan waivers, direct benefit transfer, power for all, better MSP prices, aggressive food grain procurement, import restrictions etc.

We have seen a considerable rise in rural sector allocations, both at the state as well as central government level. Several state governments have already declared farm loan waivers, which based on media reports and our assessment can be worth ~Rs3.0 trillion on an all-India basis. Utilization of funds under MNREGA stands at 65% of total availability of Rs313bn (year to date in FY19). We believe that based on increased share in cost of materials & wages, we expect the full year spending to be ~Rs650-700bn v/s the budgeted Rs550bn in FY19RB (Rs557bn in FY18).

The government’s attempts to increase realized prices for the farm sector and thereby boost rural consumption demand will add to the inflation momentum. Average CPI is likely to increase by 5.4-5.8% in FY19E. Food inflation at CPI and WPI is expected to increase by ~170bps and 330bps, respectively, on account of higher MSP, rise in procurement and various other government initiatives to increase farm sector realizations.

The pace of growth in food subsidy, which was budgeted to grow at 20.7% yoy, might increase sharply to 31.4% (~ Rs1.85tn v/s Rs1.69tn BE), as very limited provision for MSP was provided in the budget. Taken along with the impact of higher oil prices on fuel and fertilizer subsidies, the aggregate subsidy for the central government could near Rs3.0tn v/s Rs2.64tn BE.

To summarize, the build-up towards the general election and disruptions caused to the farm sector by demonetization (Nov’16) have impelled considerable fiscal and policy commitment towards the farm and rural sectors. This will continue to support consumption demand, given the multiplier effect of government spending.

The flip side is rising inflation and increased supply of government papers. In the process of remonitisation, currency supply at Rs19.6tn has already crossed pre-demonetisation level of Rs18tn. This trend will continue going forward, resulting in lower money multiplier and requiring higher pace of money printing by RBI. Decline in RBI foreign currency reserve to USD383bn from Jan’18 peak of USD400nm is reinforcing this imperative.

Tightening liquidity conditions have already led to a steep rise in 10-year G-sec yield to 8.05% from a low of 6.4% a year back. We think G-Sec’s fair value now stands at 8.4%. We believe that RBI is expected to increase the policy repo rate by another 50bps to 6.75% before the end of FY19.