A look at key implications of changing food policies in India

In the past couple of months, the government has announced a slew of measures to benefit farmers which include the increasing of minimum support price to 1.5 times the cost of production.

These measures, however, have both economic and political ramifications, given low rural income growth and upcoming elections, a Nomura report stated. Here's a list of key implications of these measures:

The report estimated that the effective MSPs should rise, but by much less than the suggested headline of ‘1.5x cost’. It further added that the weighted average kharif (summer crop) MSP hike could double to 12.9 percent y-o-y in FY19 from 6 percent in FY18.

MSP for for paddy may rise by 11.6 percent and jowar, ragi and nigerseed by 40 percent. Given rabi (winter crop) mark-ups or margins are already high, the rabi MSP rise should be lower at 6.6 percent (versus 7.4 percent in FY18).

The recent rise in MSP may impact the food prices and cause inflation. "The one-time upward adjustment to MSPs in FY19 could add 60bp to headline CPI inflation over the next two to four quarters," the report said.

According to the report, the impact of these measures, especially MSP, is likely to dissipate in the second year unless costs escalate sharply, however, there are fears that the introduction of MSP may worsen the existing cobweb cycle.

A cobweb cycle refers to a phenomenon where the prices of certain goods witness fluctuations that are cyclical in nature. For instance, if a producer received a very high price on the last year's produce, he/she may want to increase their output expecting the same demand the following year. This, however, might lead to overproduction and cause prices to slump that year, thus leading to losses.

These measures add to the fiscal costs of the government, however, the figure is estimated to be less than 0.1 percent of GDP.

The government may take care of farmers' losses via either a price deficiency payment scheme (government compensates farmers for losses) or a market assurance scheme (government buys crops to make MSPs effective).

Since higher MSPs and increased food-linked fiscal costs are an upside risk to inflation, there are chances that the RBI may tighten its policy, however, the report stated that this time the authority may leave the policies unchanged.

"We currently expect policy rates to be left unchanged through 2018, as the resolution of bank balance sheet stress is ongoing, underlying inflation is 4.5 percent and financial conditions have tightened," the report said.

The next kharif MSP announcement (in May/June) will provide more clarity, the report said.

The report stated that these policies should benefit farmers and enhance farm incomes, but these policies alone are insufficient to significantly lift rural incomes.

The government may have to balance the maintaining prudent macro policies and reducing agrarian stress. It may also have to deal with political ramifications that would come wit these measures.