The Union Government has substantially hiked the minimum support prices (MSP) of 14 commodities for the 2018-19 kharif season. This is in keeping with the promise made in the Union Budget for 2018-19, of fixing MSPs at 150% of the cost of production. The hike in MSPs is indeed very impressive—ranging from 4% for arhar and urad to 52% for ragi, with a median hike of 25%. The scale of increase can be gauged from the fact that the median increase during the last four years was 3-4%. This massive hike is expected to yield a handsome return of more than 50% over the cost of production to farmers—as high as 97% for bajra and 60-65% for urad and arhar! The prime objective of this hike is to ensure higher incomes to farmers. The announcement of MSPs is only an important first step in meeting the objective. The more crucial step is ensuring that the farmers get the MSP. The mechanics of this are unclear in the policy pronouncements so far.
What are the possible ways of ensuring that the farmers get the (announced) MSP? The first option is public procurement. However, our record of public procurement inspires very little confidence. Out of 25 commodities for which MSPs are annually announced, at present, only rice and wheat are procured in a sustained way, that too from a handful of states. Sugar, pulses and cotton have some mechanisms in place, but have proven largely inadequate with frequent gyrations in prices. Even rice and wheat are not disposed of in a timely manner by the Food Corporation of India (FCI), resulting in frequent buildup of stocks, pushing up the open market prices.
Procurement, storage and distribution requires large physical storage space and marketing infrastructure. The fiscal costs of procuring, storing and distributing even two grains—rice and wheat—have proven to be quite substantial. In such a scenario, is it possible to undertake the procurement of such a large number of commodities? The answer is clearly in the negative.
Therefore, some alternatives need to be explored. One important, but hitherto untried mechanism (except in MP on a pilot basis), is the price deficiency payments system (PDPS). PDPS is a system in which the farmer is free to sell in the open market and, if the market price falls below the MSP, the government steps in and makes a deficiency payment which is equal to the difference between MSP and the market price. As this system does not involve public procurement, the costs on account of procurement, storage and distribution are avoided. Also, the system retains the incentive effects of MSP.
However, one difficulty is to operationalise the system effectively. For example, there needs to be a record of the quantity and price of each sale and since the farmer is free to sell anywhere (village market, local trader, among others), it becomes practically impossible to collect and collate this data for millions of farmers. Therefore, it becomes necessary to restrict sales in a designated location to, say, a mandi. Even then, the mandi price will keep fluctuating through the season, and even during a single day.
Thus, the deficiency payments will be different for different farmers—larger for farmers who sell at lower prices and vice-versa. This has two adverse effects. First, the farmer will have little incentive to look for the best possible price in the market since he will be compensated for the difference (moral hazard problem). The second is that the farmers may sell inferior products under the PDPS, which is likely to fetch a lower price or may even result in them remaining unsold in an open market (adverse selection problem).
A major limitation of PDPS is that it is a counter-cyclical payment (the farmer gets a higher payment when market price is low and vice-versa). This insulates farmers from the market and may not help in market development or improving the market price for farmers. This implies that government intervention in the market needs to be continuous. Since the demand side is completely ignored (because of the assured price), the farmer is unlikely to adjust supply in accordance with demand. This may result in frequent instances of supply outstripping demand, which can create problems for finding market outlets.
Madhya Pradesh implemented a variant of PDPS on a pilot basis, called the Bhavantar Bhugtan Yojana, during the kharif season of 2017-18. The evidence from this confirms many of the issues discussed above. However, most of these problems are not insurmountable. A differentiated MSP based on quality and a dovetail with e-NAM (electronic national agricultural market, to help farmers discover the best price) may help in addressing the moral hazard and adverse selection problems. Perhaps limited procurement will help in lifting the market price and may help limit the fiscal costs of PDPS. A carefully-designed PDPS, with partial procurement and a dovetail with e-NAM in mind, is probably the correct direction to proceed in.
Direct payments is the third option. Under this system, a payment is made directly to the farmers based on a historical area, yield and price of a crop (or few crops) registered by the farmer. The farmer is not required to actually produce the crop(s). He is simply paid a lump sum amount and is free to produce crops of his choice. This system is expected to affect the supply and demand in a minimal way. Many countries, such as the US and China, have adopted this system. Now that the MSP hike has been announced, the Centre needs to carefully think through the framework of implementing this policy.
Professor, Institute of Economic Growth and honorary director, Agricultural Economics Research Centre, University of Delhi