The bond market has been concerned about the MSP hike as it could add to inflation expectations, strain government finances and force RBI to raise rates. However, given that the government has budgeted for the hike in its food subsidy bill and paddy, which has the highest weight in the food inflation basket, is not likely to raise food inflation substantially. 10-year government bond yields at levels of 7.90% are trading well above the repo rate of 6.25% and have factored in multiple rate hikes.
The MSP is positive for equity markets as the higher payout to farmers would increase rural consumption. On a political angle, the market may look at the rural support that was waning, coming back to the current government, which could help them in 2019 polls.
The Central Government recently raised the minimum support price (MSP) at which the government will buy all Kharif crops for the 2018-19 season. The Cabinet Committee on Economic Affairs (CCEA), approved the MSP of 14 Kharif (summer-sown) crops (Table 1).
The central government said in its February 2018 budget that it would buy crops at 50% over the cost of production, a major shift after keeping the minimum support price in low single digits over the past three years. Although the MSP has been announced, the implementation looks difficult as most of the crops are not procured directly by the Government in larger quantities except paddy and cotton. To overcome this issue, the Government has to either extend its procurement operations to all crops or organize the direct transfer of funds to farmers.
Impact on Inflation
The above table shows the contribution of kharif crops to total India CPI inflation (Table 2). Paddy contributes the most i.e. 4.7% to the CPI inflation as compared to other kharif crops. Thus, the increase in MSP is likely to increase the food inflation to some extent.
Impact on Fiscal Deficit
It is estimated that increase in MSP of 14 kharif crops would result in an additional burden of Rs 150 billion. However, Union Minister Arun Jaitley said the government fiscal deficit target would not be breached on account of higher MSP for 14 crops as large provisioning for food subsidy has already been made in the Budget for the current fiscal. In the 2018-19 Budget, the government has provided Rs 1.7 trillion towards food subsidy.