Indian agriculture has some stylised facts that need to be put in perspective. Most crops are grown once a year and post-harvest they are stored and made available throughout the year. Different States have variations in the months of harvest which hence makes the season longer. Next, prices tend to come down sharply when the harvest comes in and rises subsequently. Intermediaries add value by holding the stock for the entire year and bear the cost of carry — such as transportation, storage, interest and risk of damage.

Given this broad structure under which agriculture operates, the government has been pursuing the MSP programme where minimum support prices are offered for all crops just before the sowing time for both the kharif and rabi seasons. The idea is that farmers are aware of what price they could possibly get from the government in the worst-case scenario of prices coming down sharply at the time of harvest. Theoretically, this is a sound policy as it gives assurance to farmers of a fair price. As it based on a scientific formula that covers all costs plus a return on capital, it is fairly remunerative.

However, the major problem with this MSP is that it does not work for all crops. It works where the government has machinery for procurement and that too in specific States. The PDS system has ensured that there is active procurement by FCI for wheat and rice, which is stored according to the buffer stock norms and also used for distribution.

As it is an open-ended scheme, there are no limits to procurement, which creates a different set of problems for the government. However, for the other crops there is no systematic procurement, which means that while MSPs are announced, they are not credible if government agencies are not there to procure the crop and the farmer has to sell at the market prices.

The Table shows that the average mandi price tended to be lower than the MSP in most months, which means that if farmers sold their produce in the wholesale market they were unlikely to get the MSP and the demand-supply conditions would determine the returns. September would generally be the pre-harvest price while the bulk of the harvest would flow in October when the prices tend to come down due to excess supplies.

Time to revisit

The main takeaway is that the MSP system needs to be revisited. To begin with it should be announced only when there is back-end procurement so that it is relevant. Also, it should be across all States and not confined to those where the FCI has the requisite machinery. Access is of importance and FCI should be working with State agencies to ensure that even for paddy the market price should never go below the MSP because whenever it does it stands to reason that the farmers do not have access to the FCI.

Now while cooperatives like NAFED do get involved with procurement at times, it is not universal. If there is no or limited procurement, then the MSP actually sends incorrect signals to the farmers. As these announcements are made before the seeds are sown, farmers take sowing decisions based on these prices.

When the price looks attractive, there would be a tendency for group-think to take over and the acreage increases. This leads to higher supplies, and in the absence of a credible procurement system leads to prices coming down thus impacting the income of farmers which can snowball into indebtedness at times and other associated issues like loan waivers.

Therefore, MSP can be of disservice when an end-to-end solution is not provided.

Is there an option to MSP? A well-developed derivatives market can offer a viable alternative to the farmers and the government where a market solution is used for a pervasive problem of sale of product. As there are at least three running contracts for most agricultural products, we can have the prices displayed for the farmers who take a decision on which crop to sow and simultaneously take futures call in the market so that they are assured of the price.

The month can be chosen based on the time when the harvest would take place. The advantage is that the physical delivery need not take place and while locking into the price, the return is guaranteed. The actual sale would take place in the local market at the lower price, but the reversal of futures contract would make up for the possible lower price in the spot market.

Futures market

The way forward is to develop the futures market across all crops and ensure that multiple contracts are in force all the time, especially during the harvest time. This will help in making better sowing decisions on the crop as well as quantum that is sown. Ideally, options would be better, though they are not easy to understand. They would provide advantage of the upside and cover for the downside at the cost of the option premium. This is similar to the MSP but delivered through the market which is more efficient and can cover all crops.

This is probably the right time to review how this system has worked and since the story played over appears to be the same every year, where prices rule at less than the MSP, it may make sense to dismantle the same. As the eNAM evolves, it can also be integrated with the futures market over the next five years or so. But for sure, announcing prices that are not deliverable does not serve the larger good.

The writer is Chief Economist, CARE Ratings. The views are personal