The hike in minimum support prices (MSP) for the kharif (summer) crop is expected to impact inflation moderately, according to economists.

The hike, which on the average is 20 to 25 per cent higher than that of last year, was announced two days ago to fulfil a Budget promise of higher support prices to address farmer distress.

Experts have said that the budgetary outlays for food subsidy are inadequate to meet the new hikes, and that this could result in some pressure on fiscal deficit later.

Although economists differ on the exact quantum of inflationary rise following the MSP, arguing that it depends on the level and timing of procurement, they are of the view that the RBI may have to raise interest rates if the impact materialises.

A report from Kavita Chacko, Senior Economist, Care Ratings, pointed out that the price rise on account of the new MSP could be staggered over a few months, and a sudden spike in prices of these crops is unlikely.

Further, she added that the commodities whose MSPs have been announced, have a total weight of less than 4 per cent in the WPI and 7 per cent in the CPI. Therefore, the impact on inflation would be limited.

The maximum possible impact on inflation under various scenarios of transmission of MSP to market prices could see WPI inflation rise between 19 basis points and 75 basis points and the CPI between 27 bps and 98 bps.

Food subsidy bill

A rise in inflation would prompt the RBI to further tighten its monetary policy.

A pick-up in inflation during the kharif harvest period could see the RBI raise the interest rate by 25 bps in 2018-end. She expects the increase in the government’s food subsidy bill to be between ₹12,800 crore and ₹13,500 crore.

It could be higher if measures to compensate farmers for the difference between market price and MSP are undertaken, she said. “Higher MSPs carry inflation and fiscal costs, but the magnitude boils down to effective implementation. Assuming a business-as-usual approach will mean that the government’s procurement activity continues to be concentrated in foodgrains and few pulses, but is not enforced in the rest.

“We estimated the direct impact of higher MSPs on inflation to be 70 basis points over a year, with July’s increase to add an incremental 10 bps. This implies that for the rest of FY19, the impact will be in the range of 25-30 bps. Apart from food, some pass-through is also likely through food-processing and second-derivative industries such as textiles,” said DBS Bank’s Radhika Rao in a report.

She said that for the fiscal math, impact is likely to be to the tune of 0.1-0.2 per cent of GDP, which might necessitate higher revenue support or lower capex spending to limit any risk to the FY19 deficit targets.

She added that for the RBI, MSP increases pose an additional risk to their inflation view, besides fiscal slippage worries and higher oil prices. August rate hike risks remain on the table, she concluded.