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Minimum Support Price is defined as a price at which the government purchases crops from the farmers. It acts as a binding or non-binding price floor in the market, depending upon market conditions and the commodity under consideration, and ensures financial security and stability to the farmer. However, there is a significant contradiction among policymakers about how the MSP, which has often been regarded as a key solution to the agrarian crisis of India, should be fixed. The MSP is usually based on the recommendations by the Commission for Agricultural Costs and Prices.


Three important methods have been devised for the determination of the MSP:

·A2 method: MSP is set 50% higher than the amount farmer actually spends on farming including spending on seeds, fertilisers, pesticides, and labour.


·A2+FL method: The MSP hike in 2018 caters to this method alone. The MSP is set 50% higher than the amount that derives from adding the amount farmer spend on farming (including spending on seeds, fertilisers, pesticides, and labour) and the value of labour provided by the family members for agriculture.


·C2 method: MSP is defined at 50% over the sum of paid out costs, imputed value of family labour, interest on the value of owned capital assets, rent paid for leased-in land and the rental value of owned land. This method was recommended by MS Swaminathan while he was heading the National Commission on Farmers. When the C2 method was first introduced in 2004, it was seen as a point of inflection in the Indian agricultural sector.


Economic Implications of MSP

The price support policy was first introduced in the pre-green revolution era to incentivise farmers to adopt new technologies. Over time, it transformed to function as a binding or non-binding price floor in the market for agricultural commodities and even a measure of farmer welfare.


The first government body to introduce the idea of an MSP was the L.K. Jha Committee. On the basis of the recommendations of this committee, FCI (Food Corporation of India) and APC (Agricultural Prices Commission) was set up. The APC was entrusted with the task of fixing the MSPs of different crops. It was during this period that the idea of fixing MSPs, with reference to the costs of production for the farmers was envisioned.


The committee faced similar economic problems like the ones surrounding MSPs currently. A significant question was whether or not the MSP should be allowed to fluctuate, depending upon the total agricultural produce and season. The problem with a fluctuating MSP is simply that it may begin to function like the price mechanism, which destroys the purpose of a price floor. However, the problem with a fixed price floor, for a given period, was more pronounced. A fixed MSP meant there was no room to accommodate the surplus or shortage in the market. Since during this period, India did not have sufficient storage capacity or a well-developed Public Distribution System (PDS), this constituted as a significant issue.


One of the most influential commissions on the dynamic problem of determining MSPs has been the National Commission on Farmers. Headed by MS Swaminathan, it proposed the C2 method of calculating MSPs. His recommendations are often heralded by farming communities and are often used by the central and state governments to devise their agricultural policies. However, the C2 method of calculating MSPs has not been adopted yet. Several causes for this can be identified.


Firstly, such a large hike in the Minimum Support Price is bound to create a shortage in the market. In such a scenario, the MSP will easily rise above the market price and the farmers will be encouraged to sell a larger portion of their crops to the government. As the market will try to match up with the new-found shortage of food grains with a rise in the market prices, the overall inflation in the economy will rise. Secondly, most farmers of the nation are small and marginal and they are net buyers of agricultural commodities. With such a hike in the prices of food commodities, their real incomes will shrink substantially. Thirdly, an increase in the prices of goods produced by the primary sector will naturally spill to the secondary sector as well. As inflation increases, the farmers will be amongst the worst hit groups because their incomes are often not indexed against inflation in the economy.


The Ramesh Chand Committee, constituted to examine the methodological issues in fixing MSP, suggested that, for the calculation of production cost, family labour head should be considered a skilled worker. Further, it said the interest on working capital should be given for the whole season against the existing half season, and the actual rental value prevailing in the village should be considered without a ceiling on the rent. Moreover, post-harvest costs, including cleaning, grading, drying, packaging, marketing and transportation, should be included. The committee recommended that the cost C2 should be raised by 10% to account for the risk premium and managerial charges. Many experts believe that to address the current agrarian crisis, MSP should be fixed on the basis of the Ramesh Chand Committee’s report.


Social Implications

Despite the various economic concerns surrounding the 2018 MSP hike, many policymakers feel that this change was long overdue. The agricultural sector has been experiencing severe difficulties for the past few years. Rising prices of inputs, indebtedness, difficulty in acquiring formal credit, demonetisation, implementation of GST and an alarming number of farmer suicides have contributed to growing awareness about the dire state of the Indian farmer.

The Minimum Support Price has been, for a long time, viewed as a solution to farmer indebtedness. Although the idea is rather simplistic and overlooks some realistic parameters, some analysts feel that by increasing MSPs, the government enhances the income of the rural poor and allows them to repay their loans. Instead of farmer loan-waivers, that cause gaping holes in the financial system, the MSP makes every farmer more financially sound and capable. It even leads to a sense of psychological and material well-being because it ensures that the farming community will always get a fair price.


Is the MSP pushing up inflation and fiscal deficit?

After three years of keeping the growth in MSP to single-digit numbers, the Modi government brought a significant shift in its policy with the 2018 Budget. Analysts and economists have different opinions about whether this was the best time to raise the MSP to 1.5 times the cost of production. However, there is unanimity behind the speculation that such a move was bound to push up inflation.


India recorded wholesale price inflation (WPI) at 5.77% in June, which was a four-year high. Due to the rise in MSPs, the government would have to bear expenses of about 330 billion rupees ($4.81 billion). It contributes to less than 0.2 pct-0.3 per cent of the GDP. Some feel that such a minimal portion of the GDP may not impact the whole economy much at all. But, in the background of mounting oil prices, the rupee hitting new-lows every day and a widening fiscal deficit, the hike in the MSP may exert a larger impact on the economy than initially anticipated.

Some analysts feel that the reaction of the market has to be scrutinized to comprehend the inflationary implications of the policy. Some economists feel that for most crops, the wholesale prices are higher than Minimum Support Prices, so market disruption to a very large extent is unlikely.


However, the MSP hike in the Kharif crops has created widespread concerns. Analysts across the country have raised the inflation estimate for the country. Food items have a large 45.86% weight in the consumer price index (CPI) that the RBI tracks. Cereals and products have 9.67% weight. High food inflation can push overall inflation higher. Most bank ratings and analysts have added more than 35 basis points to inflation for FY19, as a direct consequence of the MSP hike.


Although such populist measures are generally expected prior to the election year, such a sharp rise still came as a shock. “We estimate that the rise in support prices of cereals and pulses in FY 2019 will be nearly 25 per cent, equivalent to the cumulative increase seen over the last five years. On a CPI-weighted basis, the increase amounts to 90 basis points, and thus, we expect at least 50 bps upside risk to forward-looking inflation estimate,” said A Prasanna, Chief Economist, ICICI Securities Primary Dealership Ltd.


The next big concern is the fiscal deficit. Since the additional cost incurred, as a consequence of the MSP hike, is around 0.2% of the GDP, most analysts feel that despite the hike, the government will reach its target of 3.3% fiscal deficit in FY2019. However, as the government has adopted a long-term strategy to significantly raise farmer incomes by 2022, using other policy measures and schemes, there is still immense pressure on the management of the deficit.


By Ashima Makhija and Tanya Goel

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