MSP hike: Not a viable policy option

Farmers in India do not get remunerative prices for their crops even as consumers complain of high and rising food prices. A year of good production often turns out to be terrible for farmers because of the price crash. In his budget speech, the finance minister proposed raising the minimum support prices (MSP) to 1.5 times the cost of production, to ensure remunerative prices to farmers and reduce the price risk they face.  The finance minister, however, did not clarify what cost of production will be considered for setting MSP. In an earlier article, Ramesh Chand, member of the NITI Aayog, had suggested a 50% margin over the A2+FL cost, which includes all paid-out costs and the imputed cost of family labour (FL). If so, MSP is already more than 1.5 times this cost for five of the six Rabi crops for which support prices are announced. Safflower is the only exception. Among Kharif crops, MSP was more than 1.5 times the A2+FL cost for bajra, tur and urad.

Farmers in India are under pressure to sell their produce right after the harvest, which makes their supply inelastic. (AP).
Photo-Financial Express

For paddy, the largest Kharif crop, MSP was higher than 1.5 times the A2+FL cost of production in 2017-18 in Andhra Pradesh, Bihar, Chhattisgarh, Gujarat, Jharkhand, Karnataka, Punjab and Uttarakhand—states that contributed more than 70% of the total rice procured. Thus, 80% of the public procurement of food grains is from the states where MSP already provides more than 50% margin over the A2+FL costs. What about the role of MSP in crops that are not publicly procured? Our ongoing research shows that without procurement, MSP is useless for farmers when it exceeds the market price, and harmful, when it is below it. Take the example of chana and arhar whose MSPs have been more than the market price in only two out of 17 years since 2000. Farm harvest price data shows that pulse traders use the low MSP as a benchmark and offer farmers prices close to MSP. Farm harvest prices bunch unnaturally around MSP when it should be higher. In game theory parlance, low MSP becomes a Schelling point for tacit collusion among traders.

What if the government heeds the demands of farmer leaders and sets MSP at 1.5 times the total (C2) cost of production? MSPs of most crops, except wheat, will have to rise sharply. How will the public procurement of select food crops at such high MSPs affect India’s farmers and its agrarian economy? MSP at 1.5 times the C2 cost will be significantly higher than the market price of most crops. Procurement at high MSP will result in rapid build-up of large government stocks that would need to be sold at a loss. Supply will increase in response to high and assured prices. Without commensurate increase in demand, market prices will fall and the wedge between the market and support prices will increase. The government will have to procure more grains and sell them at higher losses.

The fiscal costs of such a spiral have probably not been fully accounted for. The proposed MSP policy is not only unviable, but it also amounts to virtual public takeover of India’s crop economy. Can alternatives like the Madhya Pradesh’s scheme of bridge pricing, called Bhavantar, work? Under Bhavantar, the government pays farmers the difference between the MSP and the modal market price, but does not procure grains itself. Bhavantar is less distortionary and it saves the government hassles of procuring, storing and offloading crops; but it may not work along expected lines.

Farmers in India are under pressure to sell their produce right after the harvest, which makes their supply inelastic. In contrast, traders can afford to strategically wait for the right time to buy. An old rule of public economics tells us that the government can decide whether to transfer subsidy to buyers or sellers, but it cannot dictate how the subsidy will be shared between them.

The party that is more desperate—in this case, farmers—will get a smaller share of the subsidy. A large share of Bhavantar payments will go to traders—even if the government transfers the money to farmers’ accounts. How large the share would be depends on the supply-demand dynamics of each crop and market. There are already news reports about complaints of collusion among traders in Madhya Pradesh, where Bhavantar is being pilot tested. With Bhavantar, farm harvest prices will be 1.5 times the C2 costs only if the MSP is set further higher. Rising subsidy bills is not the only problem with following the C2+50% rule. There will be many other negative effects of this policy.

*First, crops with MSP account for only 28% of the total value of agricultural output. High MSPs only for these crops will discourage the much-needed diversification to fruits, vegetables and other high-value commodities, resulting in high food prices and poor nutritional outcomes.

*Second, a grains-obsessed food policy discriminates against smallholders, who have the comparative advantage in producing labour-intensive high-value commodities. Diversification to high-value agriculture is the only way millions of India’s smallholders can earn a decent income off their farms.

*Third, raising incentives for rice production in water scarce areas, like Punjab and Haryana, is also environmentally unsustainable.

* Finally, only 6% farmers sold their produce at MSP in 2013. The bureaucratic costs of extending price support to all farmers of India will be prohibitive.

India’s food and agricultural policies are geared to protect consumers more than farmers. Ad hoc policies—like storage limits and bans on futures trading, ostensibly to protect consumers—increase uncertainty and discourage private investments in markets. Instead of resorting to distortionary subsidies and market stifling policies, the government should invest in market and storage infrastructure, deregulate primary wholesale markets, encourage inter-state trade, set fair, consistent and predictable international trade policies, and invest in research and extension to increase farm incomes and accelerate agricultural growth.

PK Joshi is director South Asia, Avinash Kishore is research fellow, IFPRI. Co-authored with Devesh Roy, CGIAR research programme on Agriculture for Nutrition and Health (A4NH). This piece was originally published in Financial Express.

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