Farmer terms of trade: A nimble balancing act
The Centre will have to balance between curbing inflation and food prices, and ensuring cultivators’ welfare and backing rural demand growth
India’s high frequency rural economy indicators point to interesting divergences at a time when government policies on agriculture are witnessing several marked changes. Some of the variables such as tractor and fertiliser sales are not only showing a three-year compound annual growth rate (CAGR) in double digits but a very sharp pick-up in the last two months — up 72% and 36% year-onyear (YoY) respectively. On the other hand, indicators such as two-wheeler demand or real rural wage growth still languish below pre-Covid-19 levels. So, is the rural economy on the cusp of a near-term pick-up, or are there too many headwinds, which can nip this nascent recovery in the bud?
To answer this question from the perspective of the rural farm economy, both volumes and margins are important. The winter wheat crop has been destroyed by the March heatwave, leading to a wide divergence in production estimates. The Indian government estimates say 106 million tonnes ( MT), the United States Department of Agriculture (USDA) peg it at 99 MT, and that of other private forecasters are even lower. This drop in volume, from last year’s 110 MT, could be a negative for farm income, but can be counterbalanced to some extent by better price realisation for farmers.
Wholesale prices of wheat are up by 12% in the last nine months, after almost continuously declining for a year before that. In fact, the price momentum picked up after the Ukraine conflict drove a sharp rise in global wheat prices. Now, wholesale prices are firmly above the Minimum Support Price (MSP) for wheat. Rice prices in wholesale markets have risen by almost 10-11% YoY, and even for some other key crops such as bajra or soyabean, prices have increased by 40% YoY and 30% YoY, respectively over the last six months. This could be short- term favourable terms of trade for farmers since their cost of production is linked to the prevailing input prices in October-November last year when the crop was sown. In that sense, there might be some windfall gains for farmers, which is reflected in the higher rural demand momentum mentioned earlier.
However, even these favourable terms of trade for farmers could be short lived because of three potential headwinds.
First, the government is steadfastly pursuing an anti- inflationary approach and the objective of ensuring lower food inflation along with adequate supply is being prioritised.
Export controls on wheat and sugar and more liberalised imports of vegetable oil are steps in that direction. These policies are likely to put a lid on the extent of price realisation by farmers and the full benefit of the global food price increase might not be passed on to them.
Second, the cost of agricultural inputs is increasing rapidly. We have constructed a cost index for material inputs in agricultural production, which includes items such as fertilisers, pesticides, machinery, tractors, electricity, and diesel. According to this index, the cost of agricultural production has risen by close to 24% over the last six months and 20% over the last 12 months. The Commission of Agricultural Cost and Prices (CACP), which proposes MSP for different crops, also includes farm labour cost in estimating the overall agricultural cost of production, with labour cost having almost equal weight as material cost. Even after accounting for a very subdued rural wage growth, the overall increase in the agricultural cost of production is still likely to be averaging in excess of 10% now.
For terms of trade to remain favourable for farmers, the MSP increase for summer crops needs to factor in this sharp rise in the cost of production. In the last three years, MSP increases have been averaging 2-5% for different crops. We have estimated that if the MSP increase is in the range of 8-10% to neutralise the increase in the cost of production, then the fiscal cost could be an additional ₹20,000 crore and it can generate an upside risk of 35-40 basis points to headline Consumer Price Index (CPI).
The early June MSP announcements are likely to be a difficult balancing act for the government between trying to improve farmers’ terms of trade to support rural demand growth and controlling a surge in food inflation, which can derail urban demand for non-food items. This growth-inflation trade-off in setting the MSP could be further complicated by the fiscal pressure already being felt by the government because of its different measures to insulate the economy from global inflationary pressures.
Third, farmers also face another kind of “terms of trade” challenge — between food prices (their income) and non-food prices (their consumption). This indicator has been worsening for farmers since mid-2020, but over the last six months, the trend has been somewhat arrested with food prices rising again. With inflation becoming more broad-based and spreading to various non-food items, even these indicators could turn adverse for farmers going forward and become a headwind for rural demand.
Nurturing rural demand against an inflationary backdrop, with a spate of geopolitical considerations will be a challenging environment for shaping the government’s agricultural policies. Setting MSPs for summer crops could be a pointer of things to come, but more government intervention in continuously managing this delicate balance might be required.