Can the MSP hike for Kharif crops boost rural demand?

The Union Cabinet on June 8 approved a hike in Minimum Support Price (MSP) for various Kharif (summer) crops for the year 2022-23.

"In today's cabinet meeting, MSP of 14 Kharif crops was approved," said Union Minister Anurag Thakur.

The Cabinet Committee on Economic Affairs (CCEA), chaired by Prime Minister Narendra Modi, approved an increase in MSP for all mandated Kharif crops for the 2022-23 crop year.

As reported by Mint, the MSP of the common grade variety of paddy has been increased to ₹2,040 per quintal for the 2022-23 crop year from ₹1,940 in the previous year. The support price of the 'A' grade variety of paddy has been hiked to ₹2,060 per quintal from ₹1,960.

What is MSP?

MSP is the minimum price fixed by the government at which it procures crops from farmers. The government generally fixes MSP at the beginning of the sowing season for certain crops. This helps farmers to determine which crop to grow if the Kharif crop price rises before sowing.

At present, there are 23 crops on the list, including seven kinds of cereal (paddy, wheat, maize, sorghum, pearl millet, barley and ragi), five pulses (gram, tur, moong, urad, lentil), seven oilseeds (groundnut, rapeseed-mustard, soybean, sesamum, sunflower, safflower, niger seed), and four commercial crops (copra, sugarcane, cotton and raw jute).

How does the government fix MSP?

Generally, the Centre decides on MSP as per the recommendations of the Commission for Agricultural Costs and Prices (CACP) while also taking into consideration the views of state governments and other ministries and departments.

As per the CACP website, the commission keeps in mind several factors, such as demand and supply, cost of production, price trends in the domestic and international market, inter-crop price parity, terms of trade between agriculture and non-agriculture, a minimum of 50 percent as the margin over the cost of production, and likely implications of MSP on consumers of that product, before making its recommendations to the government about the MSP.

Can it boost rural demand?

The hike in MSP is a good move in the right direction as it will boost farmers' income and may also cap the inflationary pressure. However, brokerage firms and analysts do not think it will give a significant boost to rural demand.

"The government announced moderate increases in Kharif crops’ MSPs on the back of CACP’s estimated cost increases. This bodes well for keeping inflationary pressures in check. However, rural demand is likely to remain subdued with sentiments being boosted in case of a good monsoon and prospects of a bumper harvest," said Kotak Securities.

The brokerage firm underscored that the MSP increases are in line with the CACP’s estimated costs; implying that farmers’ incomes remain protected if production growth continues and costs are in line with CACP estimates.

Kotak Securities added that normal MSP price increases have had a negligible impact on market prices historically. APMC (Agriculture Produce Marketing Committee) price trends suggest that most key crops are above the MSP prices thereby negating much of the impact of the MSP hikes. With MSP increases being moderate, the risks of inflation from outsized MSPs, increases are also reduced.

Economists at YES BANK think that the MSP hike will not have any contribution to inflation as open market prices are anyways higher than the new MSP. This is also unlikely to benefit rural incomes in a significant way as amounts procured are a mere nearly 15 percent of the output.

"We do not think that MSP will be of any benefit for rural consumption demand as ruling market prices remain higher than the MSP. At this point, the high food prices are in fact a negative for rural consumption demand as most farmers in India are small farmers and would not be able to produce a marketable surplus," YES BANK said in a note.

"Beyond this, wage growth in both agriculture and non-agriculture jobs remain low while we continue to see a pressure on the MNREGS for jobs, leading to demand for jobs continuing to be higher than the supply of jobs. Overall, we think rural demand will remain muted and is a likely negative for overall growth in consumption demand in the economy," the bank added.

Some analysts, however, believe that the government's move will lift rural demand even though it may be capped.

"This will improve the farmer’s income, thus giving an overall boost to the rural demand. Another point to consider is that the prospect of a regular southwest monsoon bodes well for Kharif agricultural productivity and the outlook for food prices," said Santosh Meena, Head of Research, Swastika Investmart.

"This proactive move taken by the committee chaired by Prime Minister Modi will undoubtedly assist farmers in increasing their yields and increasing demand in rural India," said Vijay Dhanotiya - Lead Technical Research at CapitalVia Global Research.

If not, what can?

There are factors other than the MSP hike which are expected to give a fillip to rural demand in India. The forecast of a normal monsoon is one of them. IMD expects CY22 monsoons to be normal (103 percent of LPA) with probability of sub-normal monsoon at only 19 percent. The spatial distribution is also expected to be favorable, Kotak Securities pointed out.

Expectations of a normal monsoon and elevated food prices have brightened the outlook for rural income in rabi and kharif season for FY23.

"Normal to good monsoon rains in the last three years have aided kharif food grain production, up 2.8 percent year-on-year (YoY) on an average. Assuming, a normal monsoon in 2022 facilitates output, we see Kharif food grain production up 2.5 percent YoY. This comes atop a 1.5 percent YoY increase in rabi food grain output," said BofA Securities.

Increased government spending and labour absorption will also bode well for the rural demand. As Kotak Securities highlighted, large portion of rural income is derived from non-agriculture sources, dependent on government rural and capital spends.

"Actual capex has been stagnant over the past few years. While state governments are optimistic on capex targets, revenue pressures will dictate cuts in capex. Some of the rural demand weakness could be cushioned if labour absorption increases in urban areas," said Kotak Securities.

Rural demand expected to improve

Analysts believe rural demand may rebound in the second half of this fiscal year as bountiful monsoon rain, high food prices and a spike in remittances from migrant workers before the festival season boost incomes.

As per a Mint report, companies and analysts are optimistic about the rural demand.

“We have started seeing early signs of revival,” Mint quoted Mayank Shah, senior product category manager at biscuit maker Parle Products, saying so. “Hopefully, with good monsoon predicted this year and higher realization price of crops like wheat, we expect good demand from the September quarter.”

A rise in incomes of farmers and rural households is good news for packaged goods companies, appliance makers, and two-wheeler and tractor manufacturers, which have seen demand drop as price hikes to offset inflationary pressures resulted in a sharp cutback in consumption. Many companies affected several rounds of price increases since the Russian invasion of Ukraine in February led to soaring energy and raw material costs, the Mint report further added.

Analysts at Edelweiss Securities said rural demand would start improving from the December quarter.

“In our view, the (rural) slowdown will persist well into the fiscal first half, stemming predominantly from unprecedented inflation, compelling steep price hikes from fast-moving consumer goods companies, and consumers prioritizing savings over spending, given the all-round inflation. We believe the second half of the fiscal year is when green shoots will begin appearing,” they said, as per Mint.

Brokerage firm Prabhudas Lilladher is of the view that while Russia Ukraine war will increase inflation, there could be a silver lining for rural India given: (1) ₹500-600 billion additional profits from rabi crop in wheat, mustard, etc., and (2) likely gains of ₹1,000-1,500 billion for the dairy farming sector.

"We believe the bottom end of the pyramid has been protected from inflation significantly by PM Garib Kalyan Yojana (free rice/wheat/pulses/edible oil, etc.) will protect the downside," said Amnish Aggarwal, Director - Research of Institutional Equities at Prabhudas Lilladher.

Normal monsoon and weak fourth Covid wave will increase consumer confidence and boost rural demand.

Disclaimer: The views and recommendations made above are those of individual analysts or broking firms and not of MintGenie.