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Members of the monetary policy committee (MPC) flagged the possible impact of the larger-than-average increase in minimum support prices (MSP) for kharif crops on inflation when they voted 5-1 in favour of a policy rate hike.
Based on the MPC members’ decision, the RBI upped the repo rate from 6.25 per cent to 6.50 per cent on August 1.
As per the minutes of the MPC meeting, one of the six members said it is opportune to frontload a rate hike, somewhat akin to an “insurance policy”, while another member observed that the hike is to reinforce the policy action that commenced in June with another policy rate increase now.
According to Chetan Ghate, Professor, Indian Statistical Institute, the weighted average increase in MSP, based on consumer price index (CPI) weights for 2018-19, works out to 17 per cent. Compared to this, the average increase in MSP for 2014-15 to 2017-18 was 3.6 per cent.
“Higher MSPs of this magnitude have the potential of pushing headline inflation sustainably and significantly beyond the 4 per cent target for headline inflation mandated in the RBI Act.
“While the final inflationary impact will depend on the exact procurement policy, which is yet to be announced, given the magnitude of the MSP surprise, it is opportune to frontload a rate hike, somewhat akin to an “insurance policy”, said the professor.
Ghate felt that economic growth in the short run will be buoyed by a political business cycle. The adverse implications of a political business cycle on fiscal consolidation need to be carefully watched since fiscal consolidation is often a key feature of the adjustment required to contain trade imbalances.
Pami Dua, Director, Delhi School of Economics, said a larger-than-average increase in the MSPs for all kharif crops for the sowing season of 2018-19 is likely to have a direct impact on inflation in the food group, as well as secondary effects through greater purchasing power in rural areas. However, the extent of impact will depend on the nature and scope of implementation of procurement by the government.
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