The Hindu Business Line : Is a dualistic MSP the answer?

Even if the futures market is not used, the futures price can be used as a reference to announce a new MSP that is on equitable terms with the private sector offering.

There are three facts about the Minimum Support Price (MSP) programme. The first is that while the scheme exists for all agricultural crops, it is pertinent only for rice and wheat and to a limited extent coarse cereals. The second is that the MSP is calculated by the Commission for Agricultural Costs and Prices (CACP) based on a variety of factors to ensure that the farmer gets a fair price to maintain a decent standard of living. The third is that after a long time, the MSP in wheat turned out to be lower than the market price as a result of which the Government was not able to procure wheat for its own commitments and had to fall back on imports.

The alternatives

There are two logical alternatives when one reviews the efficacy of this programme. The first is to just let things be as they are and hope that one does not have a similar situation in the future. And in the case of shortage, India can take the import route without any embarrassment. But, then, this must be a conscious policy decision.

The other alternative is to actually revisit the MSP scheme and make it more adaptive to the twin objectives, namely, provision of proper price to the farmer, which also enables the government to go ahead with its procurement. But for this, one must be prepared for imports nonetheless because a shortfall in production will necessarily mean that either the private or the public sector has to go without the produce especially if consumption remains unchanged.

The last resort

The MSP should ideally be the last resort for farmers, which is also the maximum burden or subsidy the Government is willing to bear for a particular crop. Procurement adds a different dimension to the issue because the government is bound to procure foodgrains for public distribution as well as maintenance of a strategic buffer. Therefore, if there is any shortfall in production, the government is the first entity to be affected.

The government has to move to a system of dual pricing for crops such as wheat and rice. The CACP price should be the floor to protect the farmer; it can be announced at the beginning of the season. This will ensure that the farmer receives at least the MSP for his produce. The second price should be one that may not be announced but buffered for by the government; this should be the price that the government is willing to pay in case of a contingency. The contingency is a crop failure, as happened with wheat earlier this year.

A recap

Just to recapitulate what happened tin wheat, production was expected to be buoyant but turned out to be much lower than expected, by around four million tonnes. With little stocks left from the previous year as production was sub-70-million tonnes in FY-05 too, the Government was compelled to import wheat as it was unable to procure in the market with private parties offering higher prices to producers. While the `recognition time' was fairly protracted with the blame game ensuing, which included the futures market, the acceptance of a shortfall led to the import announcement — a case of too little too late.

How can we avoid such a situation?

This leads to the concept of the `second price', which the government can look at. This should ideally be an efficient futures price; this would provide a clue about the expected output at harvest. The efficient markets hypothesis states that if there is perfect information symmetry, then all players would have access to the expected supply conditions and would behave such as to create an equilibrium. This being the case, the futures market can assume the role of a signalling mechanism whereby the FCI can take a call in, say, December about what the prices are likely to be in April, that is, harvest time.

Options for FCI

There are again two options for the FCI. The first is to actually start hedging on the exchange so that it covers its possible losses or it can actually purchase foodgrains in the futures market. This may sound theoretical today as the volumes traded on the commodity exchanges are small given the quantities that the FCI will be targeting would be in the region of 14-16 million tonnes. In fact, such a sudden sale transaction could distort the market considerably. But, surely, a beginning can be made, with smaller quantities.

Alternatively, even if the futures market is not used, the FCI can still use the futures price as a reference to announce a new MSP so that it competes on equitable terms with the private sector and is not taken by surprise.

Change in mindset

For this model to work, however, the Indian mindset needs to change. Futures trading should not be a bad word and import of wheat should not be a scandalous term. There are certain fundamental inconsistencies in the yield and productivity patterns, which can be addressed only in the medium term. In the interim period, imports would be a necessity.

The futures market should be strengthened and the current barriers in terms of stiffer position limits, margins or stocking limits should be done away with as they serve no purpose when the fundamentals are weak. In fact, the current measures have weakened the futures market but not arrested the price rise as the fundamentals cannot be changed overnight.

There is need for a freely functioning futures market in agricultural products with participation from the FCI to make the market more efficient and provide the right solutions.

(The author is Chief Economist NCDEX Ltd. The views are personal.)

More Stories on : Agricultural Policy | Insight

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Importance of financial literacy

Why financial system must legitimise moneylenders

Why public sector oil companies fight shy of actively hedging price risks

Accounting for hedging transactions

Quo vadis arbitration in India?

Hail the NRIs

Rural India going global

Is a dualistic MSP the answer?

Precision farming

Globalisation and poverty