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Friday, July 01, 2022

ExplainSpeaking: What farmers should be demanding instead of MSPs

In the coming week, all eyes will be on RBI’s estimates for GDP growth and inflation rate

Written by Udit Misra , Edited by Explained Desk | New Delhi |
Updated: September 28, 2020 9:44:18 am
Farmers shout slogans as they block a railway track protesting against the new farm bills, at Devi Dass Pura village, about 20 kilometers from Amritsar (AP)

Dear Readers,

Looking back, this week saw the debate on the farm sector reforms, as well as the protests against it, intensify.

Even though everyone accepts that most states had already liberalised the way mandis function, and that most of the farm trade is already happening in the private sector, the protestors continue to demand the government puts it in law that no one can buy farm produce at less than the so-called Minimum Support Prices (MSPs) that are announced by the government.

This is both odd and unfortunate.

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Odd because if the problems of India’s farm sector could be simply resolved by the government decreeing that no one would purchase anything at less than the MSP, then India’s agriculture sector would not have been as unremunerative as it is. An explained piece looking at the data from the farm sector brought out what ails with Indian agriculture.

Asking for an MSP guarantee to be legislated into a law is the same in approach as asking the government to cap all medicine prices (ExplainSpeaking has written about it in the past) or asking the government to order everyone by law to pay high minimum wages etc.

Of course, governments are expected to intervene when there is extreme distress. But, if all problems of India’s economy could be resolved by the government intervening in all markets and arbitrarily fixing prices, then any government would have done that in one day and everyone would have been happy.

Politicians often use this wishful yet patently incorrect thinking to win votes. For instance, they may tell farmers that MSPs would be increased by 50% while also promising the consumers that food prices will be reduced by 50%. And while such promises are being made, they may also be telling market observers that government deficits will be brought down even as they tell taxpayers that relief is on the way.

This approach can sustain because, for instance, the consumers never stop to ask how food inflation will come down by 50% when MSPs to farmers go up by 50%. Same holds for farmers, so on and so forth.

But the truth is that there are trade-offs in any policy choice. Higher MSPs will either result in costlier food or higher subsidies and higher government budget deficits (and higher inflation) or higher taxes (to make up for the deficit) etc.

The unfortunate bit is that in the ongoing political slugfest little attention is being paid to what is likely to be the more important policy factors deciding whether or not farmers would be better off from here on.

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Three such factors come to mind.

One is the need to ensure that the government lets farmers benefit from the free play of markets. In other words, when prices rise, let farmers benefit from it instead of, say, arbitrarily imposing an export ban or allowing cheaper imports to cushion the blow on consumers.

Two, the need to create supporting infrastructure that allows farmers to avoid making distress sales. Adequate and efficient warehousing can be a game-changer.

Farmers shout slogans as they ride tractors towards New Delhi in Noida (AP)

Three, not letting greater free play of the market degenerate into an unregulated and exploitative regime. Let there be structures that provide timely regulation of trade outside mandis and allow for effective grievance redressal mechanisms.

These factors, instead of demanding an unviable blanket MSP guarantee, will be more influential now that these reforms have been set in motion.

Apart from the farm Bills, the other big story was the Permanent Court of Arbitration ruling in favour of Vodafone in the Rs 22,100-crore (retrospective) tax dispute. Slapping taxes retrospectively, initially started under the UPA regime, has severely dented India’s tax policy credibility. If the government does not appeal, it would have to pay Rs 85 crore to the company and the tribunal.

The third big story was the Comptroller and Auditor General (CAG), among other embarrassing reports, finding that in the first two years of the GST implementation, the Centre wrongly retained GST compensation cess that was meant to be used specifically to compensate states for loss of revenue. The Union Finance Ministry has countered the CAG’s findings.

Looking ahead, the biggest issue of concern will be the RBI’s monetary policy review, which is expected on October 1. Before that, possibly sometime on Sunday, it is expected that the names of the three new government-nominated members of the Monetary Policy Committee will be announced.

Also read | Explained: In three ordinances, the provisions that bother protesting farmers

There are three key issues to watch out.

One, what will be the annual GDP growth estimate put out by the RBI?

With each passing month, every professional forecaster has been throwing up a worse level of contraction for the current year. The latest was the National Council for Applied Economic Research, which said that it does not see the GDP growing in any of the last three quarters of this financial year. However, the pace of GDP contraction is expected to slow down from —24% in Q1 to —12.7% (in Q2), —8.6% (Q3) and —6.2% (Q4).

Two, what will be the RBI’s estimate for inflation?

For most of the past year, retail inflation (which is what the RBI targets) has been above the central bank’s comfort band. The red line in the chart below (Source: Nomura) has just shot up and stayed well above the 4%-mark that RBI targets.

On the face of it, it can be argued that the second half of this financial year will see inflation moderate primarily because of the base effect. In other words, since prices shot up quite fast in the second half of the last financial year, the price rise this year may appear relatively less sharp in comparison, and hence lower inflation rate.

Source: Nomura

Some economists, like Sonal Varma of Nomura, also point out that underlying inflation is far more benign than what the headline numbers suggest. The black line in the chart represents the 10% trimmed mean. In other words, it excludes 10% of each of the highest and lowest CPI inflation components each month and thus captures the trend in the more stable 80% of the basket.

The black line is substantially lower than the red. It means prices are not high across the board and some commodities, say food articles, may be exaggerating the inflation rate. This exaggeration is crucial because it could be misleading policymakers into thinking that inflation is quite high — and thus they should not be cutting interest rates — when in reality it is not — and there is space for cutting interest rates further.

However, the most important question for the RBI is to decide whether the current high inflation is just a “transient” phenomenon, due to the pandemic, or is there a possibility that such high prices over a sustained period have started making people “expect” that high inflation is here to stay more “permanently”.

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In monetary policy calculations, such “expectations” about inflation often are more relevant than actual inflation. That’s because consumer behaviour — that is, your decision whether you have enough income or what to do with it (spend more or save money) etc. — often depends more on what you “expect” the inflation rate to be over the next three months to 12 months.

Lastly, everyone would be interested in knowing if the RBI decides to cut interest rates or not.

The broader consensus is that the RBI is unlikely to do so — primarily because it is more concerned about high inflation at present even though GDP growth is the more “permanent” concern.

Stay safe


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