In a liberalised market economy, it is important to have a flexible price intervention mechanism
Currently, the minimum support price (MSP)—which is a price guarantee to farmers—is applied by the government to 25 farm products. 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. Therefore, MSP acts as an insurance cover to cultivators against the possible of a post-harvest crash in market prices and also has a strong influence on the level of open market price.
In fixing the procurement price of a particular commodity, the Commission for Agricultural Costs and Prices (CACP) claims to rely on various criteria, ranging from the production cost to the international price situation. However, the weight given to each of these criteria is not explicitly stated. With regard to the cost of production (CoP), CACP takes into account the actual paid-out cost of purchased inputs, including purchased labour and some imputed value for land and family labour (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.
However, a comparison between CoP and MSP, done by the author in his latest book called Agricultural Prices and Production in Post-reform India, clearly shows that in case of wheat, until 1997, the level of MSP remained very close to what the cost of production of was. After 1997, it started to become higher than 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 reason for this was a strong pressure on the government to bring parity between domestic and international prices, as international prices boomed during 1995 and 1996 and were much higher than domestic prices. However, when global prices started falling after 1997 and reached almost 25-year-low levels around 2000, the same has not been reflected in support prices. Again, during 2006, 2007 and 2008 when open market prices were very high along with the increase in global prices, procurement prices were also raised substantially. However, after some time when the situation reversed, the same has not reflected in procurement price.
The pattern clearly indicates that under the current price intervention mechanism, MSP have moved only in one direction, which is upwards. It has never been adjusted downwards in response to sharp fall in international price or domestic open market price. It has become almost an established norm in the country to either increase MSP every year or leave it unchanged.
The outcome is that whenever open market prices deviate from MSP, the procurement at MSP by government agencies leads to immediate distortions in the market. It is easy for the government to increase MSP or keep it at the same level when market forces actually require, but when the situation reverses, it is not possible to lower procurement prices mainly because such changes are politically unacceptable and unpalatable to farmers as well.
The unidirectional change in MSP has resulted in increased burden on the state exchequer coupled with reduced availability of food. For example, in 2008, wheat production was 78.4 MT, of which 7.1 MT ended up as a net addition to the government stock between April 1, 2009, and April 1, 2008, leaving only 71.3 MT available for domestic use. In sharp contrast, during 2007-08, when wheat production was 75.8 MT, wheat available in the domestic market was 74.7 MT. This indicates that bumper production of wheat resulted simply in swelling up of the buffer stock and making less wheat available for domestic consumers. This was an outcome of high market prices induced by MSP.
Therefore, in a liberalised market economy like ours, it is important for the government to have a flexible price intervention mechanism, i.e. allowing it to move up as well as down in response to the changes in market conditions.
The mechanism through which it can be done perhaps lies in the earlier system of price intervention in agriculture, i.e. by maintaining the distinction between MSP and procurement price. In which MSP can be announced before the start of the sowing season and serve as a guarantee to farmers against the fall in the price below a threshold level, and procurement price should be kept above MSP at all times. Procurement price can further be adjusted upwards or downwards depending upon the situation and should be used as a benchmark for foodgrain procurement by the government. Unfortunately, the distinction between the two was abolished long ago with MSP becoming the actual procurement price for foodgrains for government agencies. However, in order to keep the price intervention flexible, it is better to maintain a clear distinction between MSP and the procurement price.
The author is faculty, National Institute of Bank Management, Pune. Views are personal