Resolving the Wheat Crisis: Business Standard, 22nd September 2007

Using futures to fix procurement prices is a good idea as this will link them to global prices and appears the only way to get farmers to sell their stocks to the government.

There are four interesting facts about the wheat scenario in India. The RBI Annual Report indicates that wheat production this year has been 74.9 million tonnes which is 5.5 million tonnes higher than that last year. The second is that the government is importing wheat at close to $390 per tonne. The third is that the procurement this year by the FCI has been 11 million tonnes which is higher than the 9.2 million tonnes last year but still lower than the targeted amount of 15 million tonnes. The last is that the minimum support price offered to the farmers was Rs 850 per quintal, after an additional bonus of Rs 100 was offered to them over the Rs 750 announced earlier, when it looked likely that the procurement target would not be met.

These facts are interesting for more than one reason as they individually raise a series of issues which need to be pieced together cogently. The first question is whether or not production is really higher than what it was last year. This is important because the import of wheat needs to be justified on grounds of lower production.

If the production number is correct, then the government is importing wheat because it is not able to procure the same from the farmers. In fact, with a marketed surplus of 63 per cent, there is actually 47 million tonnes which has come to the market (or partly held at home) of which only 11.1 million has gone to the government. Why should this be so?

The farmers are not selling because either they want a better price and are progressively aware of the market prices thanks to futures trading (before the ban) or due to the entry of private players. This, in turn, means that the price of Rs 850 offered is very low. A farmer may feel that he deserves a better price considering that the government is paying $390 per tonne which works out to over Rs 1,500 per quintal as global prices are on the rise due to supply issues, which is 75 per cent higher than what was offered to the Indian farmer.

This issue could have been ignored as being an unusual aberration but for the fact that the government has had a problem on the procurement end for the second successive year — the first was a deficit production year, while the second has been a year for surplus. Evidently, a strategy needs to be devised to ensure that there is no repetition of the same in the next year.

The basic issue goes back to the government procurement of wheat. Procurement has a bearing on the output perception, the future minimum support price (MSP), the current price as well as import decisions. Ideally the government may have to review the MSP system as the MSP is supposed to be a price support system and not necessarily a procurement aid. By attempting to target both the objectives with one instrument, a contradiction has arisen. In fact, economic theory always says that rarely can one achieve two objectives with one instrument.

This is so, as we have noticed that the farmers have become progressively more aware of the market conditions and are in a position to demand the same from the government. Therefore, even in years of good production such as 2007, while production has been steady, the procurement programme has run into an impasse.

It is said that some of the private players were offering prices of over Rs 2,000 a quintal for some grades of wheat. If this were so, then evidently there is a market price which is quite different from the MSP and we need to either change the MSP calculation or keep it as a benchmark and use the market to get signals for procurement.

The futures market was providing valuable signals of the wheat price, which can provide an alternative for determining procurement prices. The futures price can be used to fix the MSP so that the FCI is able to purchase the requisite amount at a fair market price. Hence, we will have the traditional MSP which serves as the base price, while the futures price will be the actually Implemented Procurement Price (IPP).

The IPP could be variable with the market price or also fixed in advance based on the futures price so as to be market-aligned. An analogy could be borrowed from the money market here. This would be similar to the bank rate and the repo rate, where the bank rate is the benchmark, and the fixed repo rate mimics the same based on market conditions through the RBI policy. This way the farmers are assured of a fair price which is the market price. If the market price falls to low levels, then the benchmark MSP could be used for the same purpose. This would eschew the need to import wheat when there are surpluses in the country.

The major problem here is that the MSP is serving as a base price-cum-procurement price which is progressively becoming anachronistic in a market-driven system. Private players are pushing aggressively for wheat given the retail boom, which is only going to explode further. Futures markets had provided price information to a considerable section of the farmer population so that they could ask for a higher price in the market. The government, hence, has become just another player that will have to procure at market rates.

Again, to draw a comparison with the G-sec market, the T-bills which were issued to finance the budget got away with a 4.6 per cent rate prior to liberalisation. Once this segment opened up, the government had to pay a higher rate. So, shouldn’t the same thing happen in the case of wheat?