Tuesday, February 10, 2009

MSP and inflation

Despite the WPI based inflation falling to a low of 5.07% for the week-ended January 24, compared with the 16-year high of 12.91% in August, inflation rate in food articles is still at a high 11.14% for the same period. Businessline draws attention to the possibility that the increases in Minimum Support Prices (MSP) could be exerting upward pressure on foodgrain prices. The table below shows how the increases in MSP have affected the prices of various commodities.

To understand the theory, MSP is a price stabilizing mechanism where farmers are assured a minumum price for their produce. To that extent, it is more of a counter-cyclical measure, to kick-in when the prices move adversely downwards. By raising MSP even when the prices are not declining or rising, the market signals get distorted and the price momentum gets shifted un the upward direction. And given the large quantities procured, the impact on market prices is substantial. The time has come to have a fresh look at the MSP mechanism. One alternative is proposed here.

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