Law on MSP may not benefit farm sectors

A new deal to reshape the country’s antiquated agriculture sector has hit a dead-end as protests simmer over three new laws that farmers say will hurt their incomes.

The reforms allow businesses to freely trade farm produce outside the so-called mandi system controlled by the government, permit private traders to stockpile large quantities of essential commodities for future sales and lay down new rules for contract farming.

Farmers fear the reforms could pave the way for the government to stop buying staples at federally fixed minimum support prices (MSPs) and would leave them at the mercy of private buyers.

The government has insisted it will still buy staples at MSPs, but farmers have demanded a law guaranteeing minimum state-set prices for all major farm produce. The aim is to prohibit sale of any farm produce below the MSP threshold.

MSPs, which began with the Green Revolution, mainly benefit paddy and wheat growers because the government procures only these two commodities in sufficiently large quantities.

Indian farmers receive lower-than-international prices for their produce because of increasing costs of cultivation, inadequate markets and the government’s obsession with keeping food prices low. This has worsened agriculture’s terms of trade, measured as a ratio of prices of agri-products to prices of manufactured items. The crisis, therefore, is not one of low production, but of low prices.

“An MSP is an important policy tool that helped achieve food self-sufficiency because it gave farmers assured prices. It is an important price signal. It is an administrative exercise that does not have statutory backing,” said Abhijit Sen, a farm economist.

While the government announces MSP for 23 major crops, setting them at 1.5 times the cost of cultivation to account for inflation, analysts say a blanket law mandating that no trader can buy any farm commodity below this threshold price makes little economic sense.

The most immediate impact of such a law will be a higher inflation. Higher MSPs prima facie lead to higher overall prices. “Every 1 percentage point increase in MSPs leads to a 15-basis point increase in inflation,” said economist Sonal Varma. A basis point is one-hundredth of a percentage point.

Economists say an MSP mechanism that ignores dynamics, such as demand and global prices, creates distortions. If it is not profitable for private traders to buy at federally fixed MSP, when demand is low, then the private sector will simply exit the markets. In such a scenario, the government simply cannot be a monopoly buyer of all produce.

The government already procures staggering quantities of surplus rice and wheat, which have become unmanageable. As of September 2020, the government held 70 million tonnes of rice and wheat in federal stocks, whereas food-security norms require reserves of 41.1 million tonnes as of July and 30.7 million tonnes as of October each year.

If MSP is made mandatory, then India’s agricultural exports could become non-competitive because the government’s assured prices are way higher than both domestic and international market prices. No trader would want to buy at a higher price and export at a lower rate.

So, the assumption behind the new changes is that free competition in agricultural markets will ultimately result in a market-clearing price, at which quantity supplied equals quantity demanded, resulting in equilibrium.

According to economist Ashok Gulati, the cost of procuring, storing and distributing rice to the poor comes to about Rs 37 a kg. For wheat, it is around Rs 27 a kg. The cost to company (CTC) of labour of the Food Corporation of India (FCI) is six-eight times higher than private labour. Therefore, market prices of rice and wheat are much lower than what it costs the FCI to buy the staples.

On the other hand, the MSP policy benefits farmers only in a handful of states. The 70th round of the National Sample Survey showed only 13.5% of paddy growers and 16.2% of wheat growers actually received MSPs.

While MSPs have incentivised foodgrains over other crops, they have given rise to serious imbalances of water and land resources and shifted land away from crops such as pulses and oilseeds, necessitating costly imports. Also, MSPs, as administered prices, tend to distort market prices. They often ignore the demand side, international prices, export competitiveness and ecological impacts of crops such as paddy.

This also means surplus stocks can’t be exported without a subsidy, which invites the World Trade Organisation’s objections. WTO rules cap government procurement for subsidized food programmes by developing countries at 10% of the total value of agricultural production based on 1986-88 prices in dollar terms.

“Support to farmers can never be in question. But support in the form of MSP, which is market-distorting, raises questions such as whether can we move to other ways of supporting farmers that cause less collateral damage,” said Pravesh Sharma, a fellow at New Delhi’s Indian Council for Research on International Economic Relations.