The steep hike of 28% and 26% in the minimum support price (MSP) on medium-staple and long-staple fibre cotton respectively has come as a surprise, for two reasons. One, the MSP hike comes after five consecutive years of only single-digit MSP increases. The last such hefty one was 29% and 22% respectively in 2013. Two, the cotton prices currently are higher than the proposed MSP, because of the deficit in global and domestic supply.

Is higher MSP for cotton redundant then? Yes, in the short term. However, given the recent pest attacks and reduction in crop acreage, MSPs will work well to keep farmers committed to cotton cultivation, in spite of adversities.

The proposed MSP ensures a 50-60% return over the cost of production. Given that India is now the largest producer of cotton after it overtook US and China in 2015-2016, it pays to support farmers in cotton growing. Besides, MSPs mitigate the risk of price volatility too.

But, in the longer term, a steep rise in Indian MSPs will set the stage for a high floor price in both domestic and global markets.

This could puncture the fortunes of spinning mills. Note that the large integrated mills fared well in the last three to four quarters. Ebitda (Earnings before interest, tax, depreciation and amortization) margin had improved by 100-150 basis points (bps) year-on-year for the March quarter.

A report by Icra Ltd says that the MSP revision may elevate working capital requirements for mills. This, in turn, would warrant a calibration of the end product pricing, to accommodate the upward shift in cost trajectory. Larger mills that stocked up low price cotton may not feel the impact in the near term, but smaller ones would bear the brunt of high raw material cost.

In such a scenario, the key to spinning mills’ profits is high demand for yarn and the ability to pass on cost pressures.

Besides MSP, another development at the global level is China’s retaliatory imposition of 25% duty on yarn imported from the US. This could indirectly foster cotton yarn exports from India.

With the festive season ahead, demand for yarn in home markets should be stable too. So demand for cotton should stay strong.

To sum up, while high MSPs would engage farmers in cotton growing, the higher floor price could impact profit margins of spinning mills if demand slows down.

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