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Will the extra generous MSPs work?

posted Nov 1, 2011, 4:50 AM by Puneet Goyal
The authorities must address supply-side issues without resorting to MSP, as a sudden spurt in MSP will only have a cascading effect on the retail prices of wheat, edible oil and pulses.
Has the government lost its way in controlling inflation? Despite repeated tightening of credit by the Reserve Bank of India (as many as a dozen times in some 16 months) and despite claims of bumper agricultural crops in 2010-11, inflation has defied all predictions, remaining stubborn and untamed so far.

The irony of the situation was brought out succinctly a day before Diwali, when two seemingly conflicting announcements were made. The RBI announced a 25-basis-point hike in the short-term indicative policy rate (repo rate), hoping that inflation will moderate in the coming months; almost simultaneously, the Government announced a generous hike (15-38 per cent) in the minimum support price (MSP) for rabi crops such as wheat, oilseeds and pulses.

The belief is fast gaining ground that the MSP exercise is clearly targeted at farmers in the two politically-important States of Uttar Pradesh and Punjab, both of which are set to face Assembly elections in a matter of months. How the government distances itself from this suspicion remains to be seen. Adding credence to the suspicion is the report that two Union Ministries — Finance and Food — were opposed to the sharp MSP hike for rabi crops.

No one need grudge the assurance of higher prices to farmers; production costs are indeed rising. Input costs, including that of fertilisers, and labour costs have escalated over the last year. It is, of course, another question if such costs have risen to an extent that justifies a 38 per cent hike in MSP. The climate is another factor that can be erratic.

However, there is no guarantee that a hike in MSP will result in higher production. Under Indian conditions, the supply response to prices is rather limited. Yet, higher support prices for wheat, rapeseed / mustard and pulses (chana, masur) means the benchmark price will immediately move higher in the open market by 15-38 per cent.

More damaging is the naïve belief among policymakers that higher assured prices will encourage growers to produce more. The relationship between MSP and output is, at best, tenuous. Examination of the support price and output data of recent years will establish no positive correlation on a sustained basis.

With around 27-29 million hectares under wheat, 14-15 million hectares under various pulses, and 6.5-7.0 million hectares under rapeseed / mustard, there is already competition among the three crops for acreage during the rabi season. This competition is already eating into traditional acreage for coarse cereals such as jowar and maize, as a result of which the acreage under coarse cereals has steadily declined to 62 million hectares in rabi 2011, versus 69 million hectares in rabi 2009, and 66 million hectares in rabi 2010.

Land constraints are already being felt. The crop shift is slowly becoming a reality, from coarse grains to oilseeds and pulses in the rabi season. As said earlier, such a shift is happening at the margins, give or take a million or two hectares from one crop to the other.

One can decipher some logic in the hike in MSP for pulses (chana and masur). Having raised sharply the MSP for kharif pulses last year, the government may have wanted to put all pulses — kharif and rabi pulses — almost on par in terms of support prices. But a hike in MSP for rapeseed / mustard by Rs 650 a quintal, to a new high of Rs 2,500, is a shocker. The justification for such a decision is unclear.

There is danger in such a generous hike, which is unrelated to market conditions. One may recall the events, three years ago, when prices of rapeseed / mustard declined below the MSP of Rs 1,700 a quintal. Farmers were willing to sell, and indeed did sell, at around Rs 1,500-1,600 a quintal. Much of it was purchased by private traders and intermediaries who, in turn, re-sold the material at the MSP of Rs 1,700 to NAFED, which was directed to undertake price support operations. Farmers did not receive the MSP, but intermediaries did, and made a killing.

At Rs 2,500 a quintal MSP for rapeseed / mustard, there is strong likelihood of the same story repeating itself in rabi 2012. How the government proposes to ensure that growers get the MSP remains a mystery.

A large increase in MSP is sure to have a cascading effect on the retail prices of wheat, edible oil and pulses. And, as ‘a rising tide lifts all boats', there is a risk that the upward price pressure will rub off on other food commodities as well.

To be fair, there is reason to believe the government wants to address supply-side issues in the food sector. But it labours under the mistaken belief that price assurance will do the trick. It will not. We have to seriously address several structural issues that stymie farm growth. Without this, growth will remain a chimera.
(This article was published on October 28, 2011)