HSBC Securities and Capital Markets believes the recent increase in minimum support price (MSP) for key food items is likely to result in only a marginal rise in inflation.
Citing that there was a lot of pressure on the government to increase MSPs on the backdrop of deficient monsoon predictions, a report by HSBC Chief India Economist Pranjul Bhandari with economist Prithviraj Srinivas said, "The government decision is not just good news for inflation and macro stability, but also an indication of prudent policy making."
The government last week raised MSP for paddy by 3.7 per cent which is the major crop of the kharif season, against an increase of 3.8 per cent last year.
Over all, across all other crops, the average increase in MSP increase this year is under 3 per cent year-on-year. The only exception is pulses, where the MSP has been increased 6 per cent.
An increase in MSPs not only impact inflation but also influences farmers' choice of crop he would want to grow in the coming season. The report also suggests that increasing agricultural productivity is the long term solution for rural distress in case of a deficit rainfall whereas increasing MSP significantly is only a temporary solution to it.
The government's decision to slightly increase the MSP is in line with the recommendations of Commission for Agricultural Costs and Prices (CACP) which recommended small increase in MSPs based on input costs and international prices.
The government has also announced a bonus of Rs 200 per quintal on pulses to encourage farmers to move from surplus paddy to deficient pulses production. India currently has surplus rice stocks, and India has also been an exporter of rice for several years but a prominent importer of pulses.
Although the shifting of crops may not boost supply of pulses straight away as crop switching is a complex exercise, it could have a positive impact over the medium term.
"We don't expect decision on pulses, per se, to add significantly to inflation. Market prices are already running ahead of MSP prices and since India is importing pulses, international prevailing prices are likely to matter more on the margin, than the domestic policy." the report said.
There was a considerable pressure on the government to increase MSPs significantly in order to improve farmer incomes and spur rural demand but according to the report it has a limited reach.
"We believe that MSPs would do a rather shoddy job in improving farm incomes, as its reach is rather limited. It is only effective for two of the fourteen kharif crops for which MSPs are announced… there are other channels such as crop insurance and increasing spend on rural infrastructure, which would do a far better job in supporting rural incomes and livelihoods," the report added.
High MSP increases the risk of high inflation considering surplus rains in the first fortnight of the monsoon season. If the government does a good job in food stock management, like last year, inflation outcome can be contained but any further move by announcing big bonuses on key crops above the MSP hikes could undo the impact of the prudent policy decision of modest MSP increase.