India: The changing politics of food price inflation – Nomura

Indian government policies are shifting from supporting consumers (keeping food price inflation low) to supporting food producers (raising food prices), which has both economic and political ramifications, given low rural income growth and upcoming elections, suggests the analysis team at Nomura.

Key Quotes

“These policies have been implemented via larger minimum support price (MSP) hikes (at least 1.5 times the production cost), trade policy (higher import duties/easing of export barriers), fiscal transfers (to ensure farmers reap the MSP benefits) and other state government announcements. We see five key implications of this change in policy.”

“First, our estimates suggest the weighted average kharif (summer crop) MSP hike could double to 12.9% y-o-y in FY19 from 6% in FY18 – with a rise of 11.6% for paddy and over 40% for jowar, ragi and nigerseed. Given rabi (winter crop) mark-ups or margins are already high, the rabi MSP rise should be lower at 6.6% (versus 7.4% in FY18). Thus, MSPs should rise, but by much less than the headline ‘1.5x cost’ suggests.”

“Second, the one-time upward adjustment to MSPs in FY19 could add ~60bp to headline CPI inflation over the next two to four quarters. The shock is likely to dissipate in the second year unless costs escalate sharply. Our concern is that the MSP increases have been announced just as the cobweb cycle started to become adverse.”

“Third, there are fiscal costs to the government, but these should be less than 0.1% of GDP. Transfers could be made via a price deficiency payment scheme (government compensates farmers for losses) or a market assurance scheme (government buys crops to make MSPs effective).”

“Fourth, higher MSPs and increased food-linked fiscal costs are an upside risk to inflation and have increased the likelihood of policy tightening. 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% and financial conditions have tightened. The next kharif MSP announcement (in May/June) will provide more clarity.”

“Finally, farm incomes should benefit from this change in government policy, but these policies alone are insufficient to significantly lift rural incomes. Thus, reducing agrarian stress while maintaining prudent macro policies will be a test of balance for the government and could also have political ramifications.”