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Hope on the impact of MSP is misplaced

V Kumaraswamy | Updated on August 13, 2019 Published on August 12, 2019

Procurement and distribution of commodities must be studied in tandem to determine the actual benefits to farmers

 

There is growing frustration over the government’s procurement of key grains under its Minimum Support Prices (MSPs) not being able to lift the open market prices of those commodities and benefiting the farmers. What the policymakers and economists forget is that our MSP procurement is not an end in itself, but has to be studied with its end use — distribution of such procurement under our PDS programmes and how they work at cross- purposes.

Effect of procurement

It is generally assumed or hoped that once the MSPs are increased, the open market prices will also rise in sympathy. There is insufficient realisation that such procurements hardly create incremental demand.

The government has limited flexibility in increasing the quantities procured under the MSP, which may be a surer way of enhancing prices; increasing farm productivity from the current levels only harms the farmers’ interests, rather than helping them.

The effect of procurements under the MSP is quite often overestimated. It is necessary to visualise the impact of procurement operations to separate the reality from hope and wishes.

Let’s try and understand the impact through graphical exhibits. Chart 1 shows the demand from buyers at various prices, in decreasing order of prices. The thick ridge line at the top forms the demand curve as is depicted in the left figure.

Any procurement by government agencies at any price leads to a kink (figure on the right) in the normal demand curve. It shifts the demand curve horizontally in proportion to the quantity bought (dd’) at the price point equal to the MSP for the crop.

In Chart 1, due to the government’s initial extra demand, the total demand increases. But as we will see later, once the government supplies the same though the PDS, the effect is neutralised.

 

 

Chart 2 studies the combined effect of demand and supply of the same commodity as in Chart 1. The normal demand curve DD’ (without intervention) shifts to Ddd’d” after procurement.

 

The supply curve is shown as SS’. The market price without any government intervention settles at P(Free).

When the government intervenes and procures dd’ from the market at the MSP price indicated, it will move the market price of independent sellers or buyers, which will not be equal to the MSP; it will settle at lower levels.

Where it will settle depends upon the elasticity of the supply curve; the flatter it is, the lesser will be the price increase. In agricultural markets, there are many tiny suppliers whose cost structure hardly differs from one to another, since many inputs come heavily subsidised or free to most players.

Hence the supply curve is often flat and highly elastic. The market price will settle at P(MSP) which is way lower than the MSP, but higher than the free market price of P(Free).

It is a fallacy to think that hiking the MSPs from the current levels will result in higher open market prices. Unless the quantities procured are increased year-on-year (which will keep pushing the dotted d’d” segment further and further to the right), mere yearly MSP increases will have nil or negligible impact on open market prices. Where the P(MSP) settles will depend more on the width of dd’ than where it is above the P(Free) levels (MSPs below the free market prices are useless anyway).

That’s the reason why formulas like 50 per cent over all-in cost of farmers will prove innocuous, except benefiting those fortunate to sell their crops at the MSPs directly by the government.

Given the current levels of buffer stock in FCI warehouses, any significant increase in procurement quantities will be a hazardous exercise.

Effect of PDS distribution

The crops procured under the MSP are used in supplying them at cheaper (than free market prices) cost through the public distribution system to end consumers.

This has the effect of changing the supply curve from SS’ (without PDS operations) to Sss’s” (figure on the right in Chart 2).

This will lower the open market price, which may even settle at levels lower than the initial free market price, as is the case in Chart 2. Will the total quantities bought and sold expand as a result of these operations?

Indeed it will, since production will increase due to price support and so will consumption, since more people at lower levels can afford to buy more due to the lower PDS prices.

The difference between procurement and PDS supplies will be accretion/depletion to buffer stocks.

Way out

The production of agri commodities has been surplus to requirements for several years running. The buffer stocks with the FCI are far more than norms, and the credit to the FCI from banking system is at uncomfortable levels.

One way would be to export the surpluses and not supply the same back in home markets through the PDS. Or, sell it to private sector for food processing.

Alternatively, it can allow food processors and exporters to procure crops at the MSPs and reimburse the difference between market price and the MSPs to them. This way, at least the handling/storage loss can be reduced.

Simultaneously, the government should reduce the size of the PDS physical distribution and reimburse the consumers through Direct Benefit Transfers, even if the consumers buy their requirement through the open market.

A method to tweak the supply curve by the partial rationalisation of subsidies on inputs to increase the market prices and thus benefit the farmers was also explored in ‘How the Agrarian Crisis can Be Eased’ (BusinessLine, June 24, 2019).

It is time we realised the areas where the MSPs and the PDS can be effective and where they can’t be, and not be fooled by misplaced faith and theories.

The writer is author of ‘Making Growth Happen in India’

Published on August 12, 2019

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