Simple solutions for policy conundrums that we often overlook: Economic Times 21st June 2012

Very often we keep looking at the bigger picture and search for complex solutions, when there are easy options available. This holds especially for policy. While there are contentious issues like fuel subsidy or economic reforms we get into a muddle when there are rigid conflicting views that thwart decision making as in a democracy we have to balance diverse opinions. But there could be easy choices. First, let us look at the fuel subsidy. It is true that diesel, which is subsidised by around Rs 10-12 per litre, is being used by passenger cars, especially high end ones. To make them pay the market price, there are two options. The first is to simply mark certain locations, maybe metro cities or predefined urban areas and supply diesel at the market price. True, at the margin, vehicles would move over to a nearby territory and buy subsidised fuel or trucks would have to pay more in these cities. But there would be savings nonetheless and a beginning would have been made. The other is to track the number of diesel run cars - a guesstimate is that there could be around 5 million as there are around 40 million passenger cars of which, say, 5% run on diesel. An annual tax could be levied on all them through the insurance policy, which is mandatory. Assuming a consumption level of Rs 100 litres a month or Rs 1,000 litres per annum, at a charge of Rs 10/litre, a sum of Rs 10,000 could be added and collected from all owners. This is superior to the proposed tax on diesel cars as it will be a continuous flow. Insurance companies could be given a commission to incentivise them. Second, one of the reasons for inflation is high minimum support prices (MSPs) offered by the government. Given that these prices are operative only for rice and wheat where there is public procurement, the others are superfluous from an economic standpoint. They simply add to the benchmark prices in the market and do not go on the basis of demand-supply metrics as for all other crops the market prices are higher than the MSP. By abolishing these prices, we could let the market determine the prices and not have the government indirectly push them up. Third, we have an anomalous situation where high production of rice and wheat coexist with shortages in the market. This is so because the FCI has an open-ended procurement policy where foodgrains are finally hoarded by the state. With the government procuring around 35% of wheat produced and another 30% being used for self-consumption, the market actually gets only 35%. A solution is to cap the amount of procurement while giving cash payments to those who do not sell to the FCI. This way the subsidy remains, but the shortages are addressed. Fourth, we are divided when it comes to FDI in retail and there are strong explanations on both sides. We can think of getting in foreign capital to a limited extent in the existing outlets of, say, all state cooperative stores. These outlets already exist and by laying down conditions of employing existing employees and bringing in the capital and technology, we can strengthen these cooperatives, like Sahakari Bhandars and Apna Bazars, which will be more palatable. Fifth, we get worried when the exchange rate moves up or down as we are used to having guidance from the RBI. Forex is like any commodity and the price should be determined in the market. The RBI should not interfere once the rules are laid down. If the rupee keeps falling, imports automatically become dearer, travel less attractive while exports receive a thrust and inward remittances receive more rupees. Equilibrium will follow in course of time. Sixth, in the money market, there is a tendency to support liquidity without any limit which creates distortions. The RBI should fix the amount of money that can be borrowed through the repo window and let the market decide thereon. Call rates will surely get spooked, but will be representative of liquidity conditions and banks will use their money more effectively. Presently, due to forex intervention, the RBI is squeezing liquidity and then providing the same around the corner through the repo window. This is quite unnecessary.

The Indian BRIC is firm in the wall: Financial Express June 20, 2012

The Indian economy is going through tough times, and it is not surprising that the government has been held responsible for the current state, which appears to be the standard response to any negative economic stimuli. The latest is a view that the economy looks fragile enough to warrant a downgrade in future. While rating of countries is the prerogative of the rating agency which has its own criteria, it would be interesting to examine how India is faring vis-a-vis the other BRICS nations as the context has been against this background. This will show whether, objectively speaking, there is a case of under-performance of India vis-a-vis its peers. It is also acknowledged that the situation is nowhere as close to what it was in 1991 when the crisis set in. This calls for a comparison of economic indicators. One of the issues that have been raised is GDP growth. Using The Economist’s data on various variables (see table), India is to grow by 7.1% in 2012, which comes next only to China with 8.2% but faster than Brazil (3.3%), Russia (3.5%) and South Africa (2.8%). (South Africa, with a better rating, is a later addition to the concept of BRIC and is not part of the comparison drawn by the rating agency.) Clearly, despite the low growth scenario of India, things are not looking cheerful elsewhere. In fact, the rating agency also acknowledges that growth would be 6.5% this year for India, which implies at worst stagnation and not deceleration. Even the World Bank in its latest Global Economic Prospects talks of growth being 6.9% over 6.5% last year. Therefore, on grounds of growth, India is quite vibrant in relative terms. Inflation is higher in India at 7.7%, followed by Brazil and South Africa with 5.4% and 5.3%, respectively. The others have lower inflation numbers. This is not unsettling as it is not structural in nature and is more on food and fuel sides where extraneous factors have prevailed. Core inflation remains manageable around 5%, which would be of utmost concern. Clearly, this is not an important issue for looking at a downgrade. Third, the current account deficit is worrisome and is expected to be 3.1%, which is higher than Brazil at 2.7% but better than South Africa with 4.6%. China has a positive balance while Russia is in surplus due to the benefit of being oil-producing. The deficit has been driven by two factors: import of gold and crude oil. The former has been curtailed through taxation, while the decline in crude oil prices will provide a cushion to this account. This number will definitely improve. Fourth, if we look at the depreciation of currencies, the picture is fairly uniform across nations. While we do appear to feel the brunt, it is the same even in Brazil and South Africa and to a lesser extent in Russia. Globally, the decline in international trade has affected exports of most countries, which coupled with increasing oil prices exacerbated current account deficits. Global capital flows were tardier, which put relentless pressure on currencies. To top it all, the strengthening dollar against the euro, for reasons not linked to the dollar but more due to the weakness of the euro, has caused other currencies to take a hit. With the exception of China, all others have witnessed weakening of their currencies. Again, India does not fare too badly to be an outlier. Fifth, the size of forex reserves is another important factor that talks of the stolidity of the economy. Our forex reserves provide some cushion here though, admittedly, they are of a lower order than that of the others, except South Africa. But the import cover is still fairly comfortable at around 6-7 months, assuming imports of $40-50 billion per month. Last, the budget balance is lower than South Africa only, but given that all debt is internal, poses no risk to the outside world. The debt-to-GDP ratio is lower than most developed economies at just less than 50%. Therefore, based on pure objective economic indicators, India appears to be better on some parameters or on par with the other peer nations and, prima facie, there appears little reason for the country to stand out as a sore thumb within this group. The next issue pertains to the qualitative part on economic reforms, which has been a grievance even internally. To counter this argument, it could be said that all the reforms that are being spoken of are not new and have not been there even when the economy was rated better. Also while reforms may not have taken place at the desired pace, there has never been an instance when the government, irrespective of the political party in power, going back on such policies. Therefore, to assume that the government would be going back on reforms in the external and financial sectors is probably debatable. In fact, financial sector reforms have been only progressive, with the country now having one of the most robust systems that has remained unaffected by the two crises that have afflicted the world economy. All this means that, objectively speaking, the economy has been on par with its peer nations group, and while there is definitely discomfort since we have deviated from the high growth path, we are not alone in this state. This is the message that needs to be considered when making a comparison.

Realistic Portraits: Business World: 25th June (Book review)

Mark Tully's latest book is a journey through India, a county he revisits after almost 20 years Mark Tully is one of the more respected writers and commentators on India, known as he is for his unbiased and non-condescending approach even before we became a dominant emerging market. Non Stop India (Penguin), his latest, is a journey through the country he revisits after almost 20 years. It is a travelogue where he selects a subject and the regions for his investigation and gets the people to speak about it. He makes it clear that it is not his view that is being forward. The book has politics, economics, sociology and ecology embedded, making the story an interesting read. One does get a full-yet-partial view of the state of the country. It is full because it spans a wide canvas in terms of subjects, and partial because it only covers specific regions. It is left to the reader to decide whether or not one can generalise these observations. There are 10 chapters covered in this Tully experience. It starts with ‘Red India’, which is all about the Maoist movement that started off with the tenet that all resources belong to society and should be equally shared. But he points out that over time this ideology has gotten diluted and perverted to becoming an anti-industry crusade that finally has degenerated to terror. The absence of development, however, is the reason for its germination. One is not sure if Tully has deliberately kept this as the first chapter as it makes one stop and think of the real state of progress in India. He then moves over to caste and its deep-rootedness, where he traces the drudgery of dalits, but points out that things have changed significantly over the years and there is much empowerment even though consciousness has not yet changed. Lower castes are still treated like different beings though they do have some say in education and governance. The chapter on vote banks is entertaining, though we already know what he says. The way elections are held and the cards political parties play to score votes (such as caste) are quite deep-rooted in our systems. Tully is quite right when he talks of why women such as Mayawati click because dalits see her as an instrument of emancipation for their community. Everything else is really forgiven. The role of the media in elections and the money that passes through are again something familiar. At the same time, Tully appreciates Nitish Kumar's achievements in Bihar. His coverage of the impact of religion through the famous TV serial Ramayana is interesting. He traces the growth of fundamentalism of a different variety, which culminated in the demolition of the Babri Masjid, which is more factual rather than a critique. He then focuses on the section called ‘Building communities’, which is vintage Tully. We get a view on how the development programmes of the government work as he covers rural employment scheme MGNREGA in Rajasthan in detail. He shows that even in the limited geography he has looked at, there is resistance to such schemes. The conundrum is as follows: economists think it is a waste of money, sociologists think it fosters corruption, politicians and bureaucrats are rarely interested in schemes they cannot control. But, generally, it works still, which is encouraging. The book meanders into farming where the focus is ‘contract farming’. Pepsi’s venture into contract farming has been a success story as far as Punjab is concerned even though there are disparate tales heard. Some farmers feel let down with such contracts where their produce is rejected on ground of poor quality when there are surpluses. But the fact that 90 per cent of the farmers are still with them vindicates their own position that they are working with the farmers, says Tully. He praises the spirit of enterprise in India, despite all the bureaucratic delays and corruption. There is a bit of history on how the Birlas and Tatas had to maneuver their ways earlier, but find it easier today, though the recent controversy of lobbying is a reflection of the lacunae that still exists. Tully’s has delivered a book of hope and recognition for the development that has taken place in a country of contradictions. While he does not exactly round up his narrative, the title suggests that he believes that India cannot be stopped if we are willing to tighten the strings. Non-Stop India By Mark Tully Penguin Books India

The Group For Change: Business World 18th June 2012

The book is an excellent exposition of a comparative economic picture of the Brics and here is scope for leveraging this strength and importance for global growth The concept of Brics nations as a ‘group’ is a misnomer. Today, the idea portrayed is that there are these five nations working together with mutual interest to move ahead and in the process provide support to the world economy. The fact is when this concept was invented, it simply meant choosing the four largest emerging markets (later on South Africa joined) and extrapolating their growth prospects based on some bold assumptions that looked inviting at that time. The Brics met recently in Delhi to promote mutual economic interests, but remain quite disparate in terms of economic structures, politics, governance, social mores and diplomacy. Also, there is little physical proximity that promotes such an alliance. It is against this context that one should read The BRICS Report, an output of the finance ministry. The report is an excellent exposition of a comparative economic picture of the Brics, which account for about 25 per cent of the world GDP and 40 per cent of the population. Intuitively, there is scope for leveraging this strength and importance to bring about global growth. The report, rightly, does not support the decoupling hypothesis — that their prospects are not really delinked from the West. It does note that while the financial crisis proved this group did better than developed economies and drove ahead of the world economy, there were strong links with developed nations through trade, finance, commodity and, above all, confidence. But a recovery here was swifter. This underlined their relative domestic strengths, which included resilient and well-regulated financial systems. The timing of this report is interesting as these nations seem to be struggling as much with the present sovereign debt crisis as the developed ones. The report showcases the strengths of these nations and highlights how they have built their own foundations. Interestingly, they followed unique models of development and growth. Brazil had farming, biofuel, anti-Aids missions, conditional cash transfers and regulation of capital flows, which helped it come forward. Russia worked on reforms and inflation and its major gains were on the budgetary side with the oil stabilisation fund working well. India worked on the 8-9 per cent growth path, which was spearheaded by private initiative. Caution was exercised on capital account convertibility, a prudent thing to do. The report also talks a bit about the RTI and MGNREGA programmes as major gains. But in the current scenario, quite a few of these achievements would come under question. China’s transformation from a controlled to open economy is well known and its capacity to create infrastructure and welcome foreign fund has been amazing. South Africa’s sound macroeconomic management and the orderly development of its financial sector have made it a major power for the entire continent. While balancing these strengths with challenges, the report points to what the countries should look at closely. The answers are more generic in nature in terms of reforms, financial sector development, efficiency, social spending, etc. But importantly, it talks about areas of cooperation. They are general in nature as given the size of the economies, and that they have started talking to one another, there are a plethora of opportunities for them to work together for mutual benefit. But, for this to work, there should be consensus on trade and investment issues. Hopefully, this report should reach policymakers of all the five countries so that they can get down to examining the feasibility of leveraging synergies. While it is not clear whether this is an official document, there are acknowledgements to various experts from all the nations, which add weight to the notion that going ahead, there could be something happening in terms of cooperation within the group whose influence can transcend the region. The Brics Report: A study of Brazil, Russia, India, China and South Africa with special focus on synergies and complementarities New Delhi Brics Oxford University Press India

RBI ain’t got no magic bullet: Financial Express: 8th JUne 2012

A lot being made of the imperativeness of RBI to lower interest rates to help the economy? Given that RBI has been increasing interest rates relentlessly in the last two years to control inflation, a view put forward is that Mint Street has been responsible for coming in the way of growth. The corollary is that, as this has not helped curb inflation, it should roll back rates to bring about growth. Is the equation as simple as this? There is no doubt that lower interest rates will help growth in two ways. First, lower costs on working capital improve profits. Second, lower rates make the internal rate of return on projects look better and hence can spur investment. But, is this action the be-all and end-all solution of our economic ills? The answer is a shoulder shrug. Today, government deficit, in particular its expenditure on subsidies, as well as high interest rates have been hyped, giving the impression that if these two roadblocks are addressed, the 8% gravy growth path will be achieved. This may not be true. Production takes place to satiate four sets of entities: consumption, investment, government and foreign trade. Consumption is dependent on an increase in income as well as inflation. Higher inflation has tended to deflect a part of savings for maintenance consumption, which, in turn, has affected incremental demand for consumer goods, and which explains why consumer durable goods did not do well last year. Investment is down, naturally, due to lower consumption demand as well as interest rates. In the last year, corporate profits have been affected by higher input costs and interest rates, which have not been fully passed on to the consumer. With demand down, there is no reason to invest at a high cost, which has gotten reflected in the production of capital goods where growth turned negative. The government cannot spend on projects because its deficit is high. Exports can help, but with the high trade deficit, the impact on GDP is negative. This is a rudimentary way of putting the GDP in perspective and we need all these pieces to work together to bring about growth, as they are interlinked. Now, one can turn to the last 20 years to see how interest rates and GDP and gross fixed capital formation have behaved. In the above table, growth rates have been taken for the latter two at 2004-05 prices while the same has been done to the prime lending rate and base rate for the last two years. The basic idea is to see how growth has behaved when rates have gone up—the same with gross fixed capital formation. The table shows that in these 20 years, there has been an increase in interest rates six times only. On four of these six occasions, capital formation remained robust. And while it was in a single-digit range in FY11 and FY12, this was a continuation of a pattern witnessed since FY09 when it came down, even though rates had fallen in two successive years. On three of the six occasions, there appears to be a one-year lag in terms of impact on growth in capital formation. But even so, GDP growth was affected with a lag on the last two occasions when we had the financial and sovereign debt crisis. This was curiously seen in the aftermath of the Asian crisis when growth slowed down considerably even as rates were lowered. Also, lower interest rates do not necessarily spur investment as evidently other factors such as demand and excess capacities and future prospects for growth are important. What does this indicate? Interest rate reduction by itself cannot be the magic wand we are looking for to drive the economy. The rate cut witnessed in April has not quite elicited enthusiasm from borrowers, even after being told that there would be no further hikes for some time. Evidently, there is something missing, which is holding back growth today. We need to have a consumption increase to provide impetus to investment as the government is quite impotent in this regard today, and exports are beyond our purview given the tenuous global economic situation. A related issue here is whether capital is being priced properly today. Interest rate is the price of capital and when demand is greater than its supply, the price should rise, as it holds for any good or service. Here, with RBI providing R1 lakh crore through the repo window, it looks like that there is a shortfall, with the government being the largest claimant of funds. If the government cannot be stopped from borrowing as much as it is doing, then demand will be exacerbated, thus justifying the higher cost of funds. Further, with inflation still high, the real interest rate based on the CPI is negative and around 1-1.5% based on the WPI. RBI will evidently be looking closely at all these aspects before taking a final call. While a decrease in interest rates could help lift sentiment, as it actually does not cost anything to the central bank. Savers would be impacted, but then with limited options, they have to settle for less. But we should not expect another 50 bps cut in rates to actually kick-start the economy, as while investment will gradually take place, industry will also be looking to the government to start its spending on infrastructure and private consumption to be revived. The question is when all this will happen?

Don’t defend the rupee: Financial Express: 22nd May 2012

When the rupee is volatile and there seems to be no sign of light at the end of the proverbial tunnel, it makes a lot of sense to let things be as they are. RBI has limited ammunition to defend the rupee and any kind of sale of dollars gets absorbed soon and the situation reverts to the status quo. And the pockets are not deep. The rupee is being driven by fundamentals as well as extraneous conditions. Within fundamentals there are two sections. The first is the current account deficit, which is under pressure, being close to 4% of GDP—though the exact number prevailing in May is unknown. But we do know that exports could be slowing down while imports are stable largely due to declining gold imports and lower oil prices. Invisibles could be marginally better, and hence the deficit could at best be stable. Looking at the capital account, there are four elements that can change the face. FDI has been buoyant last year, and will be steady. FIIs are still suspicious and there are outflows rather than inflows. NRI deposits are largely steady and inelastic and RBI has allowed for better returns to induce more flows. ECBs are useful, and RBI has been liberal here. But, companies will not be borrowing now as this is the non-peak season. Also, there is little investment taking place, and given the state of euro markets as well as India’s own state of economy, the rates may not be too fine in case one adds the cost of rupee depreciation to the credit risk premium. Here, evidently, RBI cannot make a difference through intervention. The extraneous condition is the dollar-euro relationship. When the Greek debt was swapped, it was felt that a solution was found. But, there are good chances that Greece will renege on its side of the deal of following austerity. The dollar will hence continue to strengthen as long as the euro region is fragile. Greece will remain in suspension till the June elections, and if it goes down and out of the euro, contagion will spread to Spain, Portugal and maybe even Italy. All this means the dollar will become stronger and the rupee will take a beating again. Will RBI intervention work here? The answer again is no. Either which way, RBI cannot really combat such adversity and it makes sense to let things be. Will this be the end for us? The answer is no. While the panic is palpable currently with cries for intervention, there is an obvious solution that has been missed here. All the affected parties should be using the F&O route and hedge their risks. The forex derivative market is well developed and surprisingly all through the crises months last year as well as this year, the overall traded volumes have remained largely stable and not increased. Why aren’t corporates hedging? Our imports could be $600 billion this year, which should ideally be hedged. Hedging is insurance for price risk, and the price here is the exchange rate. Simply put, when we see the rupee depreciate, one should go long and buy forward, so that when it does depreciate, there is cover. Similarly we have debt servicing to be honoured during the year, which should be hedged. And since there are ‘options’ available now on the forex currency exchanges, the actual cost is only the option premium. Corporates are already in the habit of hedging their raw material risks either through global futures in case of crude (NYMEX or ICE) and metals (LME) or through bilateral agreements with vendors domestically. Forex is one commodity that is generally not touched on the premise that the rupee will never really go very down and that the central bank is there to lend a helping hand. It did do so last year by pushing in over $20 billion to stabilise the rupee. This won’t happen again. The issue is that once players know that RBI will intervene, the speculative elements come in and start guessing the moves. While RBI has put curbs on exporters by ensuring that dollars in the EEFC accounts come in, importers could rush in to buy dollars or plain speculators could start punting in the market. This makes the system even more volatile and unstable as one cannot separate these elements. Markets always self-correct in the absence of intervention as more expensive dollars make imports dearer and exports competitive, which should help in bringing equilibrium. Inflation will certainly be there, but then we cannot expect some authority to intervene for each element of inflation when there are demand-supply mismatches. For the theoretically inclined, even the REER (real effective exchange rate) is at a low, which should get reflected in the nominal rate (which it does). We should certainly not hold on to an unrealistic rate merely because we are used to a dollar coming for less than a certain targeted rate.

Start worrying about those NPAs: Financial Express, 18th May 2012

While the elasticity of NPAs with respect to industrial growth has been range-bound, this rose sharply in last two quarters The issue of quality of assets of the banking system is of paramount importance, given that the future of banking will be to strike a balance between business and profit growth with prudential practices, which involves both maintaining capital and controlling the quality of assets. Basel III talks of the requirement of raising more of ‘own’ capital, which is a challenge for both public and private banks—the former because it involves issue of ownership and disinvestment and the latter because their risk-weighted assets are higher, given their business models. But, quality of assets is a concern for all banks, especially so since the economy has begun to decelerate and the overall economic conditions for FY13 do not appear to look any better than they were in FY12. Just how serious is this issue? The last two years have been particularly challenging for banks where they had to contend with the phenomena of rising interest rates for two years, and a slowdown in industrial growth in FY12. Bank credit growth, on the other hand, has been a mixed bag, being interspersed with varying trends. Chart 1 traces the movement of gross NPAs to total advances for a set of 36 banks for the last eight quarters. There has been a tendency for gross NPAs to increase between April-December 2011, from 2.25% as on March 2011 to 2.85% in December. Excluding SBI (results not yet out for March 2012), the ratio would stand at 2.40% in March 2012 as against 2.43% in December 2011 for 35 banks. These numbers by themselves do not really provide discomfort, given that it has been a difficult year for the banking system. It has however also been noticed that corporate profitability has slowed down, with growth in net profits also turning negative in the quarters ending December and March. This means that going ahead there would be pressures on corporates to perform in terms of servicing their debts. However, these numbers could be indicative of the emerging scenario of quality of assets of banks going ahead, given that the economic climate is uncertain. Chart 2 provides the movement of the elasticity of growth in gross NPAs to growth in advances along with the elasticity of growth in gross NPAs with respect to industrial growth. The elasticity with respect to advances has been high in the last three quarters of calendar 2011, which also indicates that NPAs grew faster during this time period. The second relation with industrial growth however is more interesting. The elasticity of NPAs with respect to industrial growth has been range-bound, between 0.25 and 0.38. However, in the last two quarters, i.e. September and December 2011, the elasticity has increased sharply to 0.86 and 2.42, respectively. While these numbers per se may not be significant, the indication is that in case industrial growth continues to be downbeat then the level of NPAs will increase further, which is definitely a concern. And currently, with an unchanged economic environment in the country, it looks unlikely that there would be a quick turnaround in the state of industry. In fact, with GDP growth to be only marginally higher in FY13 according to RBI, industry is likely to follow a sluggish path. Chart 3 shows how net NPAs have moved over the quarters. After showing a declining trend towards March 2011, there has been a tendency for them to rise again. This has certainly affected the profitability of banks through provisions and write-offs. The issue with growing NPAs is that it is a two-way force with economic growth. While slower economic growth increases the probability of default, the same makes banks more conservative with their lending, which, in turn, can impact growth. Banks would tend to get choosier with lending and cherry pick their customers so that the higher-rated clients are preferred. This would also lead to an increase in the cost of credit for borrowers who have lower ratings. In particular, the SME segment is to be negatively impacted as it also does not have access to other avenues like the ECB route which is open for the large companies. The other consequence is that there would be greater demand for restructuring of sticky loans, especially in case of sectors such as MSME, aviation, telecom, real estate and infrastructure including power. This would further pressurise banks. The solution really is for banks to be more discreet while lending in uncertain times. They should also have in place an early warning signal for detecting possible delinquencies and should be mapping continuously industry performance to prepare with a suitable response. Companies should be encouraged to hedge their commodity and currency risk, which are useful insurance tools going ahead, considering that economic conditions are going to remain volatile with the euro crisis still looming and domestic economic conditions still being sticky. Further, one could also think of a counter-cyclical buffer for NPAs when provisions are made in better years for covering NPAs during tough times, just as for capital as laid down under Basel III framework.

Time for a closed-ended MSP programme: 3rd April, MInt

Attention so far has been on the distribution side of the food problem and alternatives such as cash transfers have been suggested. However, another serious problem that we confront when handling foodgrains is on the procurement side which has come in the way of the development of the farm sector. Food procurement by the Food Corporation of India (FCI) is essentially a process with two objectives. The first is to ensure a fair price to the farmer and the other is to enable food security in terms of creating a buffer and a mechanism for food distribution through the public distribution system and other social programmes. To achieve these goals, we have the concept of a minimum support price (MSP) offered by the government and FCI, which physically handles foodgrains. Two aspects of MSP are that they are announced for all crops at the time of sowing, and the second is that procurement takes place only in rice and wheat, and to a minimal extent in coarse cereals. The curious thing about procurement is that it does not take place in other products because market prices are generally higher. It is also true that FCI does not have the machinery in place for the same. Lastly, procurement is active in only a few states: Punjab, Haryana, Uttar Pradesh for wheat, and Andhra Pradesh, Chhattisgarh and Tamil Nadu additionally for rice. The starting point of problems in the procurement process is that it is an open-ended scheme, where FCI has to perforce accept any fair quality of rice and wheat from farmers. There is no choice here and intuitively it can be seen that this system tends to create a farmer bias for rice and wheat. This problem will get exacerbated as output keeps rising as we also need to create the logistics support to ensure that we can progressively handle these quantities. In fact, FCI was to be the last resort for the farmer, but has ended up becoming the first preference due to the continuous increase in MSPs. There have been repercussions on both FCI as well as farming in general on account of this scheme. The first is that FCI has been procuring larger quantities of rice and wheat as MSP has been continuously raised by around 10% every year, making it attractive. This has led to surplus stocks, which are around twice as much as to be maintained, based on the buffer stock norms specified by the government. There are presently around 25-30 million tonnes lying with FCI. The economic cost of these products, as mentioned by the Economic Survey, is Rs1,500-2,000/quintal, which means around Rs43,000-52,000 crore is tied up in warehouses. The second unintended consequence is that FCI becomes the biggest hoarder of foodgrains and leads to anomalies, where shortages in the commercial market lead to higher prices for millers even when production reaches peak levels as FCI is holding on to surplus stocks. This policy of open-ended procurement combined with higher MSPs has created more serious problems for agriculture. To begin with, farmers prefer to grow rice and wheat because the prices received are getting better by the day. Therefore, they are reluctant to migrate to other crops such as oilseeds and pulses, where typically the nation runs an import bill. This has skewed the cropping pattern in the country. Further, excessive growth of rice and wheat also tends to affect the water table level as these crops consume more water, thus affecting long-term prospects of farming. Also, given that these crops use more fertilizers and pesticides which enable rapid growth, the quality of the soil tends to deteriorate over time. All this means that agriculture will face problems going ahead. What are the solutions here? First, the procurement system has to be made closed-ended where FCI can go up to a certain margin over the buffer norms. While this can be based on a first-come-first-served basis, the unique ID can be used for bringing about a quota system where FCI purchases only up to a certain level from every farmer. This would be a fair way of going about it. Alternatively, farmers can be provided cash transfers which will be the price difference between the market price and MSP. This can be achieved in a transparent manner, if they can be made to sell on electronic commodity exchanges where there is an audit trail and one can eschew adverse selection. On the cropping side, the government should aim at providing incentives to farmers growing other alternative crops such as pulses and oilseeds. A cash bonus could be considered, based again on the unique ID. Subsidized credit, power or seeds in the form of a package can be provided to draw farmers to these crops. We certainly need to move away from open-ended schemes while retaining the ethos of not diluting the present benefits to farmers in a smarter manner. Or else the skewed farm matrix will continue to dominate our farm topography, which is not desirable.