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The author analyses the inefficiencies in the MSP regime while comparing it with the sugar sector and the milk sector. The recent agri-reform in the opinion of the author could help to make the Indian agriculture more efficient.

MSP system Vs. Market-driven system

• MSP regime was the creation of the era of scarcity in the mid-1960s.
• Indian agriculture has, since then, turned the corner from scarcity to surplus.
• In a surplus economy, unless we make agriculture demand-driven, the MSP route can spell financial disaster.
• This transition is about changing the pricing mix — how much of it should be state-supported and how much market-driven.
• The new laws are trying to increase the relative role of markets without dismantling the MSP system.
• Currently, no system is perfect, be it the one based on MSP or that led by the markets, but the MSP system is much more costly and inefficient.
• The market-led system will be more sustainable provided we can “get the markets right”.

Issues with the MSP

• A perusal of the MSP dominated system of rice and wheat shows that the stocks with the government are way above the buffer stock norms.
• The economic cost (to FCI) of procured rice comes to about Rs 37/kg and that of wheat is around Rs 27/kg.
• No wonder, market prices of rice and wheat are much lower than the economic cost incurred by the FCI.
• So, grain stocks with the FCI cannot be exported without a subsidy[i.e. export below the cost], which invites WTO’s objections.
• The FCI’s burden is touching Rs 3 lakh crore which is not reflected in the Central budget as the FCI is asked to borrow more and more.
• The FCI can reduce costs if it uses policy instruments like “put options”.

2 Lessons: from sugarcane and milk pricing

1) Populism resulted in making sugar industry globally non-competitive

• In the case of sugarcane, the government announces a “fair and remunerative price” (FRP) [not MSP]to be paid by sugar factories [not paid by the Government].
• While some states like Uttar Pradesh announces its own “state advised price” (SAP).
• The sheer populism of SAP has resulted in cane arrears amounting to more than Rs 8,000 crore, with large surpluses of sugar that can’t be exported.
• This sector has, consequently, become globally non-competitive.
• Unless sugarcane pricing follows the C Rangarajan Committee’s recommendations the problems of the sugar sector will not go away.

2) Success story of milk sector

• In the case of milk co-operatives, pricing is done by the company in consultation with milk federations.
• It is more in the nature of a contract price.
• It competes with private companies, be it Nestle, Hatsun or Schreiber Dynamix dairies.
• The milk sector has been growing at a rate two to three times higher than rice, wheat and sugarcane.
• Today, India is the largest producer of milk — 187 million tonnes annually.

So, how the recent reforms will help the farmers

•  As a result of changes in farm laws in the next three to five years companies will be encouraged to build efficient supply lines somewhat on the lines of milk.
• These supply lines — be it with farmers producer organisations (FPOs) or through aggregators — will, of course, be created in states where these companies find the right investment climate.
• These companies will help raise productivity, similar to what has happened in the poultry sector.
• Milk and poultry don’t have MSP and farmers do not have to go through the mandi system paying high commissions, market fees and cess.

Conclusion

The pricing system has its limits in raising farmers’ incomes. More sustainable solutions lie in augmenting productivity, diversifying to high-value crops, and shifting people out of agriculture to high productivity jobs elsewhere, the recent reforms are the steps in this direction.

Back2Basic: What is MSP

• Minimum Support Price (MSP) is a form of market intervention by the Government of India to insure agricultural producers against any sharp fall in farm prices.
• The minimum support prices are announced by the Government of India at the beginning of the sowing season for certain crops on the basis of the recommendations of the Commission for Agricultural Costs and Prices (CACP).
• The minimum support prices are a guarantee price for their produce from the Government.
• The major objectives are to support the farmers from distress sales and to procure food grains for public distribution.
• In case the market price for the commodity falls below the announced minimum price due to bumper production and glut in the market, government agencies purchase the entire quantity offered by the farmers at the announced minimum price.

What are ‘put options’

• Put options give holders of the option the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame.
• Put options are available on a wide range of assets, including stocks, indexes, commodities, and currencies.
• Put option prices are impacted by changes in the price of the underlying asset, the option strike price, time decay, interest rates, and volatility.
• Put options increase in value as the underlying asset falls in price, as volatility of the underlying asset price increases, and as interest rates decline.
• They lose value as the underlying asset increases in price, as volatility of the underlying asset price decreases, as interest rates rise, and as the time to expiration nears.