EMPIRICAL POLICY FOR AGRICULTURE PRICES VOLATILITY

The minimum support price (MSP) acts basically as an insurance cover to cultivators against the possibility of post harvest crash in market prices. More positively, it serves as an incentive to farmers and stimulates higher production by encouraging the use of modern inputs and by inducing investment in cost-reducing technology. The MSP system was started in India in the mid-1960s to create a favourable incentive environment for the adoption of High-Yielding Varieties (HYVs) of wheat and rice, which were seen to possess a vast potential for raising grain production. After about one and a half decades of the MSPs system, the policy framework was modified in 1980, when the demand and supply of food grains appeared to be balanced. The emphasis of the Agricultural Price Commission (APC) policy (later renamed the Commission for Agricultural Costs and Prices [CACP]) shifted from maximizing food grain production to developing a production-pattern consistent with the country’s overall economic needs. Recognizing the issue of a fair split of the gains accruing from technology and public investment among farmers and consumers, the government mandated CACP to monitor the terms of trade for the agricultural sector. A review of the policy in 1986 resulted in an emphasis on the long-term perspective. This implied that to make the farm sector more vibrant, productive, and cost effective, policy should cover major factors that influence agricultural prices in the long term.

Currently, MSPs with the nature of a price guarantee to farmers are applied by the Indian government to 25 farm products. If market prices fall below the support level, government agencies buy the quantities offered at support prices. Farmers have the option to sell in the open market. While farmers are under no obligation to sell to government agencies, the latter are bound to buy all quantities offered by farmers at guaranteed prices.

The support levels are determined by the cost of production, changes in input prices, input–output price parity, trends in market prices, the emerging demand and supply

situation, and intercrop price parity; the effects on cost of living, general price level, and industrial cost structure; international price situation; and parity between prices paid and received by farmers (terms of trade [ToT]).

The trends in procurement prices for wheat and paddy show that support prices declined more in the 1980s than in the 1990s. Between 1981–82 and 1988–89, prices witnessed an annual growth of 3.26 percent and 4.62 percent, respectively. The situation started to change since then. Until the launch

of economic reforms, procurement prices were based entirely on domestic factors, mainly the cost of crop production. Though CACP was required to consider the international price situation, this aspect was never given any weight when determining the level of MSPs. As a result, MSPs were lower than the international prices. The gap between these two prices further widened with the devaluation of the rupee in June 1991. At the same time, changes in the industrial and trade policy were

introduced to expose the industry to competition by reducing the protection hitherto enjoyed by the industrial sector. These policies together with globalization brought the domestic prices of farm inputs in line with world market prices.

These factors led the government to implement a substantial hike in MSPs to reduce the gap between domestic and international prices and to compensate the farmers for rising input costs.

The procurement price of wheat was raised by more than 20 percent for three consecutive years -1989/90, 1991/92, and 1992/93. The increase was almost double the highest recorded rise in procurement price during the 1980s. As has been the case with wheat, the procurement price of paddy was also raised by about 11–16 percent from 1989–90 to 1993–94. As a result, paddy procurement price increased by more than 65 percent, from INR 185/quintal in 1989/90 to INR 310/quintal in 1993/94. These changes, coupled with various

other factors, caused a small acceleration in the growth rate of agriculture during the period 1988–89 and 1995–96.

The international prices of wheat during 1995 and 1996 boomed and were much higher than the domestic prices. In response, the government raised the wheat MSP by 25 percent in 1996–97, from INR 380 to INR

475/quintal, though the increase in the MSP recommended by CACP was only INR 25. In the next two years (1998 and 1999), CACP

raised its recommendation by 21 percent, and the government further raised the effective MSP by more than 12 percent of the CACP

recommendation. Some studies have shown that these increases in MSPs completely ignored domestic demand-side factors and were much higher than was justified by the cost of production.

After 1996, the international prices started to decline so that by 1999 they were much lower than the MSPs for wheat and paddy. It is noted that CACP recommended an increase in wheat MSP to INR 490 for 1999 and INR 580 for 2001; paddy MSP was increased to INR 440 and INR 510 for the same years. The country had already started accumulating larger than required stock of wheat and paddy in 1999; the stock level further increased to more than double the minimum norm by October 2000. In the light of the buildup of surplus stock and the domestic and international price situation, CACP indicated in its report for crop year 2000–01 that “since the present MSP was already too high the commission did not make any recommendation for wheat” (CACP 2001,445). Consequently, support prices of wheat and paddy during the period between 2001–02 and 2004–05 almost stagnated, varying only between INR 620 and INR 640/quintal for wheat and INR 530 and INR 560/quintal for paddy.

As the international prices of wheat and paddy started to dramatically increase in 2005/06, there was again a strong pressure on the government from several quarters

to maintain parity between domestic and international prices. There was also an urgency to replenish the low level of the buffer stock. Thus, government raised the MSPs for wheat and paddy for 2007 by 21 percent and 9 percent, respectively. As prices in the international market soared in December 2007, the CACP raised the wheat and paddy MSPs from INR 750 to INR 1000 and INR 580 to INR 645, respectively, between 2007 and 2008. Other than the high level of international prices, CACP had no justification to recommend such a big hike in MSPs.

In sum, increase in support prices was highest between 2005–06 and 2009–10. The price for the common paddy variety increased by more than 75 percent (from INR 70/quintal to INR 1000/

quintal) during the period 2005–06 to 2009–10, whereas, that of wheat increased by more than 55 percent. The increase was mainly on account of the high level of international prices; the global food price index increased by 83 percent between 2003–04 and 2008–09.

In fixing the procurement price of a particular commodity, CACP claims to rely on various criteria, ranging from production cost to the international price situation. However, the weight given to each of these criteria is not explicitly stated. With regard to production costs, CACP takes into account the actual paid-out cost of purchased inputs, including purchased labor and some imputed value for land and family labor (C2 cost) and some value (10% of the C2 cost) for the farmer’s managerial input. The C2 cost and the value for managerial input constitute the C3 cost, which forms the basis for the CACP support-price recommendation.

In the case of wheat, until 1997, the level of MSP remained close to its cost of production, though slightly higher. After 1997, it started to become higher from the cost of production and a large gap developed between the two. This clearly indicates that the successive increases in MSPs from 1997 onwards have permanently shifted the MSP upward on a new trend. The MSP levels almost stagnated between 2001–02 and 2004–05, lessening the gap between the two prices. The situation for paddy, on the other hand, turned out to be totally different. Its level of MSP remained very close to its cost of production throughout, except recently. It mostly stayed slightly higher than the production cost, slightly dipping only occasionally. The analysis also showed that the support price mechanism was more favourable to wheat producers than paddy growers in the 1990s. During that period, the rate of increase in paddy MSP was lower than that of wheat, distorting the intercrop price parity.

However, it is important to mention that the MSP announcement does not guarantee that the market price would not fall below the MSP. According to various reports of the CACP, there had been instances of market prices ruling below MSPs for certain crops in areas where government procurement agencies were absent. The experience shows that institutional intervention in ensuring the guaranteed price is effective only in regions and crops where government or public sector agencies procure the produce in a big way. For instance, it does not matter for producers of paddy and wheat in Chhattisgarh, Orissa, Assam, Bihar, and a majority of the other states whether the CACP recommends INR 500 or INR 5000/quintal for their crops as there is no enforcement of the MSP

in these areas. The purpose of this illustration is to bring home the point that the MSP, without an effective procurement mechanism, does not guarantee that prices would not fall below the floor set by the government.

In this context, it is more important to see the prices received by the farmers than the MSP per se. For each commodity, the prices

realized by the farmers are best represented by the implicit price received by the farmers, which is the ratio of the value of the main

product to the average yield. Until 1998–99, the real prices received by the farmers followed the MSP pattern in the case of both wheat and paddy, though the gap between these two narrowed in the case of paddy. The prices received by farmers remained higher than the MSP during this period (i.e., up to 1998–99). After this, the paddy price received by farmers had remained lower than the MSP in all years, except recently. The story of wheat is better. Though the margin between the MSP and price received by wheat farmers almost evaporated, the price they received remained higher than the MSP, except for 2001–02. The situation improved further after 2005–06.

Significant regional disparities were

observed when the ratio of price realized to MSP was considered. The ratio declined in the triennium ending 2004–05 at the all-India level in both crops. The ratio for paddy was much lower in states like West Bengal, Orissa, and Uttar Pradesh. In the case of Haryana, it was higher by 32 percent, which means that the realized price was 32 percent higher than the support price. The ratio for paddy was higher than wheat in the triennium ending 2009–10; the realized price for paddy was 3 percent higher than the MSP at all-India level in TE 2009–10.

India’s emphasis and reliance on price policy during its post-reform period and the relative exclusion of non-price interventions in the form of public investment shifted the earlier policy regime of “low input low output price” to a regime of “high input high output prices.” The analysis shows that as part of the reform strategy, the government not only slashed the subsidies on major inputs to discourage environmentally unsustainable practices but also absolved itself of the responsibility to produce or procure and distribute these inputs at farm gates. Subsequently, yield levels went down, resulting in rising costs of cultivation.

With the freeing of controls, the role played by market forces has become clearly identifiable in the unprecedented increase in variable costs. Taken together, these changes perceptibly slowed down the performance of the agriculture sector in the post-reform period.

Increases in production cost, along with the desire to link domestic prices with international prices in order to integrate the domestic economy with the global economy, necessitated higher support prices. The trend analysis of MSPs clearly shows this phenomenon. However, the MSP announcement alone does not guarantee that market prices would not fall below it. An effective procurement mechanism is needed

to help ensure that prices would not fall below the floor set by the government. This is clearly evident in the comparison of MSPs and prices received by farmers. Moreover, experience shows that institutional intervention in ensuring the guaranteed price is effective only in regions and crops where government or public sector agencies procure the produce in a big way.

The trend analysis of MSPs also suggests that, under a liberalized market regime, there should be flexibility in the intervention price

and prices should be allowed to move up and down in response to changes in the market conditions. The way MSPs had been used over a period of time suggests that the change would be unacceptable to farmers’ lobbies.

Agricultural price policy has been largely successful in playing a major role in providing reasonable margin levels over production costs to farmers of both wheat and paddy. Nonetheless, the margin over total cost and variable cost had declined in the post-reform period in both crops. The net income in real terms had declined also, leading to distress among farmers. The decline in profitability has discouraged farmers from increasing their spending on yield-augmenting

technology, resulting in poor yield growth rates and in a decline in production growth rates.

The deceleration in growth of agricultural productivity during the post-reform period had put pressure on the production of wheat and paddy; it also forced the government to take measures to reverse such trends. Since then, conscious efforts have been made to raise investments in agriculture. As a result the share of public investment by the end of 2008–09 had returned to the 1980s level. Moreover, various agricultural developmental plans to revive agricultural growth had been launched since the mid-2000s, such as interest subvention on crop loan, the national agricultural development program, the National Food Security Mission, and a special emphasis on certified seed production. These efforts have paid dividends; the agricultural sector has experienced a recovery in the production of major crops in recent years. The increase in productivity growth during the recovery phase had drastically reduced the real cost of cultivation and significantly improved net farm income during the period.