MSP conundrum
The issue of minimum support prices (MSPs) has become controversial today because of two reasons. First, the increase has gotten moderated of late, which has become a concern from the point of view of farmers. Second, the MSP has been linked to inflation, and as a corollary, it is being argued that one of the reasons for persistent high food inflation is the constant increases in MSPs which are not related to market forces.
The MSP debate is multifaceted. First, the MSP is announced for all crops—23 of them across the kharif and rabi seasons. But actual procurement takes place in only rice and wheat. If this were so, why should the ministry announce prices for all crops? Second, by announcing such prices based on providing market indications on what price the farmer can expect, the link with market forces is severed. Therefore, even in years when output is high, prices never come down or stabilise, but keep increasing. Third, the MSP has become a tool for political expediency as it helps to reach out to the farmer vote bank. The higher MSPs have created an inflationary spiral as higher inflation automatically gets embedded when calculating the next year’s MSP. More importantly, this has become a sensitive issue as it has become a debate between supposed “pro-farmer” (those who espouse higher MSPs) and “anti-farmer” groups.
The government has announced higher MSPs for the kharif crops with R50 increase for rice and a bonus on pulses. The increase for the 2015 kharif season varies from 0.75% to 6.3%, with pulses being favoured with the inclusion of a bonus. The whole idea is to provide a fair compensation and income to the farmers as well as provide them with cropping options by announcing the prices. For the latter, it may be a bit late as a lot of sowing decisions would have taken place already. The question is whether this will be inflationary or not given that higher food inflation has the potential to come in the way of future monetary policy action.
The accompanying table provides information on compound growth rate in output, MSP and WPI inflation for various farm products that enter our food basket. The period is between FY05, which is the base year for the WPI index, and FY15. While output has kept fluctuating over the years, it has been noticed that whenever prices rise as output falls, they do not revert to the base price when the output increases, and hence prices always get compounded. The same holds for MSP which can remain static but never decrease. The WPI has been chosen as it is the closest price that the farmer receives; and as these quotes are from the mandis, a major part of the intermediary cost between the wholesaler and retailer is kept out of the calculation.
The commodities have been put in three buckets. The first one consists of crops which have witnessed an increase of above 1.5% per year in production for the decade. The 1.5% number is significant as it is also the population growth rate. Typically, a thumb rule can be that growth in production should keep pace with the population growth. NSS data on consumption does show that till FY12, households actually spent less on food and more on non-food items. This being the case, the population growth rate can be a reasonable cut-off indicator. Within this group, with the exception of chana, where prices increased by 5.7%, there have been average annual increases of above 6% while the MSP increase has varied from 7.3% to 12.6%. Quite clearly, the increase in prices cannot be attributed to supply shocks—which could be there for single years, but not for the larger part of a decade. Given that the MSP increase is higher than WPI with a standard deviation of 2.0, the link between the two is quite high. Soyabean, moong, urad, rice and wheat have witnessed high growth rates in prices. For wheat and rice, the fact that the FCI procures a third of the output has meant that higher procurement leads to shortages in the private market, thus pushing prices up further (above MSP).
The second group consists of commodities where growth has been positive but less than the growth in population. Here, it is possible that demand issues have driven prices higher. Here, the standard deviation of WPI from MSP is higher at 3.2. Tur is a clear case of imports being used to complement domestic supply. Here, the link between MSP and inflation would be hazy as supply issues also have to be addressed.
The last group consists of products where production levels have come down, where the higher MSP and continued fall in output has affected prices. Here, the standard deviation is 2.6. In fact, in this category one can argue that higher MSPs have not even led to farmers growing more of the crop as the cost could be a factor along with other agro-climatic factors. Therefore, the purpose of incentivising farmers to grow specific crops has also not worked out for these products.
The linkage between MSP and inflation certainly exists in the first category of commodities. There can be no value-judgements passed since, if the farmer is really getting the benefit, then this is a useful way to improve her income. However, to ensure that it does not play with the inflation dynamics, it would be preferable to move to a system of cash transfers to farmers for crops where there is no procurement and then let the market forces of demand and supply address the issue of price discovery. This will be pragmatic being balanced and driven by objective factors and free from emotion.
The MSP debate is multifaceted. First, the MSP is announced for all crops—23 of them across the kharif and rabi seasons. But actual procurement takes place in only rice and wheat. If this were so, why should the ministry announce prices for all crops? Second, by announcing such prices based on providing market indications on what price the farmer can expect, the link with market forces is severed. Therefore, even in years when output is high, prices never come down or stabilise, but keep increasing. Third, the MSP has become a tool for political expediency as it helps to reach out to the farmer vote bank. The higher MSPs have created an inflationary spiral as higher inflation automatically gets embedded when calculating the next year’s MSP. More importantly, this has become a sensitive issue as it has become a debate between supposed “pro-farmer” (those who espouse higher MSPs) and “anti-farmer” groups.
The government has announced higher MSPs for the kharif crops with R50 increase for rice and a bonus on pulses. The increase for the 2015 kharif season varies from 0.75% to 6.3%, with pulses being favoured with the inclusion of a bonus. The whole idea is to provide a fair compensation and income to the farmers as well as provide them with cropping options by announcing the prices. For the latter, it may be a bit late as a lot of sowing decisions would have taken place already. The question is whether this will be inflationary or not given that higher food inflation has the potential to come in the way of future monetary policy action.
The accompanying table provides information on compound growth rate in output, MSP and WPI inflation for various farm products that enter our food basket. The period is between FY05, which is the base year for the WPI index, and FY15. While output has kept fluctuating over the years, it has been noticed that whenever prices rise as output falls, they do not revert to the base price when the output increases, and hence prices always get compounded. The same holds for MSP which can remain static but never decrease. The WPI has been chosen as it is the closest price that the farmer receives; and as these quotes are from the mandis, a major part of the intermediary cost between the wholesaler and retailer is kept out of the calculation.
The commodities have been put in three buckets. The first one consists of crops which have witnessed an increase of above 1.5% per year in production for the decade. The 1.5% number is significant as it is also the population growth rate. Typically, a thumb rule can be that growth in production should keep pace with the population growth. NSS data on consumption does show that till FY12, households actually spent less on food and more on non-food items. This being the case, the population growth rate can be a reasonable cut-off indicator. Within this group, with the exception of chana, where prices increased by 5.7%, there have been average annual increases of above 6% while the MSP increase has varied from 7.3% to 12.6%. Quite clearly, the increase in prices cannot be attributed to supply shocks—which could be there for single years, but not for the larger part of a decade. Given that the MSP increase is higher than WPI with a standard deviation of 2.0, the link between the two is quite high. Soyabean, moong, urad, rice and wheat have witnessed high growth rates in prices. For wheat and rice, the fact that the FCI procures a third of the output has meant that higher procurement leads to shortages in the private market, thus pushing prices up further (above MSP).
The second group consists of commodities where growth has been positive but less than the growth in population. Here, it is possible that demand issues have driven prices higher. Here, the standard deviation of WPI from MSP is higher at 3.2. Tur is a clear case of imports being used to complement domestic supply. Here, the link between MSP and inflation would be hazy as supply issues also have to be addressed.
The last group consists of products where production levels have come down, where the higher MSP and continued fall in output has affected prices. Here, the standard deviation is 2.6. In fact, in this category one can argue that higher MSPs have not even led to farmers growing more of the crop as the cost could be a factor along with other agro-climatic factors. Therefore, the purpose of incentivising farmers to grow specific crops has also not worked out for these products.
The linkage between MSP and inflation certainly exists in the first category of commodities. There can be no value-judgements passed since, if the farmer is really getting the benefit, then this is a useful way to improve her income. However, to ensure that it does not play with the inflation dynamics, it would be preferable to move to a system of cash transfers to farmers for crops where there is no procurement and then let the market forces of demand and supply address the issue of price discovery. This will be pragmatic being balanced and driven by objective factors and free from emotion.
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