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Opinion

Are ‘remunerative’ MSPs driving rural demand?

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On June 9, the union cabinet approved the minimum support prices (MSP) for the 2021-22 kharif marketing season. MSP for rice, the most important kharif crop in terms of acquisition, will be 1940 per quintal, compared to 1868 last year. The press release issued by the Cabinet Committee on Economic Affairs (CCEA) says the latest MSP offers a 50% profit margin on the projected cost of cultivation in 2021-22.

The cost measure that has been used to calculate this margin is category A2 + FL. This has been described, in the CCEA statement, as an “integral cost that includes all costs paid, such as those incurred on behalf of hired human labor, oxen labor, mechanical labor, paid rent. for leasing on the land, expenses incurred in the use of material inputs such as seeds, fertilizers, fertilizers, irrigation charges, depreciation of agricultural implements and buildings, interest on working capital, diesel / electricity for pump operation, etc., expenses miscellaneous and imputed value of family labor ”.

To be sure, many farmers’ organizations have been demanding that the government use the C2 measure of the cost of cultivation – this includes the imputed rental value of the land owned and the interest on the value of the fixed capital owned, thus including the cost opportunity to practice agriculture – in making sure MSP delivers 50% performance.

Despite this A2 + FL versus C2 controversy, a more important question deserves our commitment. How useful is EMP when it comes to boosting rural demand for the broader economy? An analysis of HT shows that the answer is complicated.

Nominal MSP growth has been low in recent years

Although the government claims that the latest MSP announcements meet the 50% margin on the A2 + FL criteria, the increase in nominal terms is not much. Rice and wheat MSPs for the 2021-22 kharif and rabi marketing seasons increased by 3.9% and 2.6%, respectively. A long-term analysis of MSP for rice and wheat, the two most important crops being purchased, shows that nominal growth in MSP has been declining under Narendra Modi’s second government.

Read also | Cabinet clears hike in MSP of kharif crops

While the first Modi government increased nominal MSPs at a slower rate than the rate of increase in most years under the first and second governments of the United Progressive Alliance (UPA), it announced a large increase in the season of 2018-19 marketing, which could have been tactically aligned with the 2019 elections.

Nominal MSPs are not enough to access the impact of demand

Clearly, the nominal growth figures for the EMP could be misleading in terms of their impact on farm incomes and thus on rural demand. Here’s why. MSPs, directly or indirectly (in terms of creating a floor price), affect the prices that farmers receive and therefore their nominal income. Demand, on the other hand, is a function of purchasing power, which is determined by relative prices.

An example can clarify this. A farmer who grows wheat sells his wheat and hopes to use his earnings to buy other things. Suppose the farmer in question wants to buy a fertilizer, a motorcycle, and a tractor with his earnings. If wheat prices double in a year and the prices of motorcycles, fertilizers and tractors increase only one and a half times, then the farmer is in an advantageous position. However, if wheat prices rise at a slower rate than other commodities, the farmer is at a disadvantage.

The best way to capture this dynamic is to look at the terms of trade (relationship between prices received and prices paid) for agriculture. The ministry of agriculture publishes these data. This is better than a simplistic comparison of retail inflation (measured by the consumer price index for rural areas) because farmers are consumers and producers at the same time. As is clear from the product list provided above, the motorcycle, fertilizer, and tractor capture the farmer’s spending on consumer, intermediate, and capital goods. A typical CPI index is not designed to capture prices of intermediate or capital goods.

Unfortunately, the terms of trade data is available with a time lag and the latest figures are for 2018-19. Statistics show that the terms of trade improved for farmers from 2004-05 to 2010-11, stalled at unfavorable levels until 2016-17, and started to decline after that. A worsening of the farmers’ terms of trade implies a decrease in their purchasing power and, therefore, in rural demand.

Breakdown of the deterioration of the terms of trade

Because the overall number of terms of trade depends on what is happening to consumer, intermediate and capital goods prices, it is important to find out the relative contribution of these items.

Data from the Ministry of Agriculture actually give the index of prices paid by these three categories and their respective weights in the farmers’ spending basket. Intermediate consumption has the largest share with 43.4%, followed by final consumption (38.2%) and capital formation (18.4%). The calculation of the individual terms of trade – the relation of prices received and paid – for each of these categories shows that the general terms of trade have deteriorated despite an improvement in the terms of trade for intermediate consumption.

The rural wage factor in the terms of trade of intermediate consumption

What explains the improvement in the terms of trade of intermediate consumption while the other two items have deteriorated? A contraction in rural wages could be the answer.

Wages represent more than 60% and almost a third of the A2 + FL cost of growing rice and wheat. Rural wages, which increased at a rapid rate until 2014-15, have stagnated in the recent past. This is likely to have created headwinds for intermediate costs to farmers and thus the total cost of cultivation.

However, this is likely to have created a second-order constraint on rural demand. If agricultural labor and farmers experience a constraint on income (rural wages and imputed value of wages), this will put pressure on purchasing power and thus the rural component of aggregate demand, including of farmers. Much of the rural poor in India are also net food buyers.

The chicken and egg connection between the terms of trade for agriculture and aggregate demand

The discussion so far highlights an interesting paradox in the Indian economy. Although the government is offering remunerative MSPs year after year, this may not have generated strong tailwinds for overall demand because the terms of trade for farmers have been deteriorating, causing their purchasing power to contract. . Of course, the situation would be worse if the MSPs did not exist.

Two factors could further worsen the terms of trade for farmers in the future. The post-pandemic nature of the profit-driven recovery and poor labor market conditions will further reduce massive incomes and thus food demand, putting downward pressure on prices. . An increase in the cost of items such as diesel and some fertilizers (the government has announced an increase in subsidies for urea) could lead to the actual cost of the crop being higher than the projected costs used to calculate the latest MSP, that only started to increase. after May 2021.

“It is not realistic to think that the agricultural economy will continue to function even though the non-agricultural part is in crisis. The agricultural sector is the buffer in terms of the labor market and the longer it takes for the non-agricultural labor market to recover, the more difficult it will be for the agricultural sector to cushion income, ”said Himanshu, associate professor of economics at Jawaharlal. Nehru University. “That is why it is important that the government provide a fiscal stimulus to both the labor-intensive component of the agricultural and non-agricultural sectors,” he added.

Are 'remunerative' MSPs driving rural demand?

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