Managing Wheat Price Volatility in India. Christophe Gouel, Madhur Gautam & Will Martin 18 September 2014

Transcription

1 Managing Wheat Price Volatility in India Christophe Gouel, Madhur Gautam & Will Martin 18 September 2014

2 Food security in India Food security: top priority for policy makers Addressed through 3 pillars: Availability: R&D, subsidized inputs (electricity, fertilizer, seeds, water, credit) and guaranteed prices. Access: largest food schemes in the world Targeted, quantity-constrained, releases of food to low income consumers Set to expand under new Food Security Bill: 820 million people should receive subsidized food. Stability: stable prices through active trade and storage policies.

3 Food security in India Comprehensive and reinforcing policy instruments: Trade policies insulate domestic markets MSP is defended by public procurement and stockpiling. Public stocks used to supply the Public Distribution System. Discretionary disposal of remaining stocks to stabilize prices. Problems: Hinders development of a private marketing network 60% of marketed surplus are procured. Costly and ineffective: Very high food subsidy bill ($15 billion) Households that are entitled can buy half of quota (Khera, 2011) Grain stocks deteriorate inadequate facilities or held too long

4 India s wheat market

5 Net trade (X-M, million ton) From importer to exporter Market year

6 Stable Production Output Variability (5 year rolling Std. Dev. - left axis) Share of Area Irrigated (% - right axis)

7 Real 2005 Thousnd Rupees/MT Stable domestic market Domestic Price Import Parity Export Parity

8 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Grain stocks vs norms 900 Total Stock (Wheat + Rice) vis-à-vis Buffer Norms and Strategic Reserve (Lakh Tonnes, Jan Aug 2014) Buffer+Strategic Reserve Total Rice + Wheat

9 Questions What are the implications of current policies? For India and the world market Can a model identify better policies? What is the optimal mix of storage and trade policies? Can simple rules yield similar results?

10 Modeling India s Wheat Market

11 Key features 2-country stochastic rational-expectations partial equilibrium model India (i) & the Rest of the World (w) Production, consumption, storage & trade A social welfare function that penalizes deviations of prices from the steady state. Design of optimal policy under commitment and optimal simple rules.

12 Producers & Consumers Producers respond to expected prices: r r max Π t t+1 = δe t P t+1 H r r t ε t+1 Ψ r H r t, where H planned output, δ discount factor, ε a random shock to output,ψ the production cost function. FOC: r r δe t P t+1 ε t+1 = Ψ r H r t. Consumers respond to current prices: D r P t r d r P t rα r, where d r > 0 is a scale parameter and α r 0 is the demand elasticity.

13 Stocks & trade Private storers arbitrage prices intertemporally S r t 0 P r t + k r r δe t P t+1 0, where S r is private stocks & k r storage costs. Trade based on spatial arbitrage opportunities X t w 0 (P t w +θ w,i )T t M P t i X t i 0 P t i P t w θ i,w T t X with X r exports from r, θ r,s transport cost r to s, T t X & T t M the power of the export & import tax.

14 Availability and market Availability (state variable) A r r r t S t 1 +H t 1 ε r t. Market clearing A t r + X t s = D r P t r + S t r + X t r for s r. Core laissez-faire model 2 state variables, A t r, and eight response variables, P t r, S t r, H t r, X t r, for r i, w.

15 Welfare Welfare: sum of surpluses + loss function. w i t = [ d i P t i1+αi ] + [P 1+α i t i i H t 1 ε i t a i H i t bi i H 2 t ] + 2 [P i i t S t 1 k i i + P t S i t ] [Cost i t ] [ K P 2 t i P i 2 ] Where Cost is the sum of public storage costs and trade policy costs; [ K 2 P t i P i 2 ] represents the dislike of policy makers for price stability. K value specified with K = γ R ν D P /P, where γ, R & ν are values of the budget share, relative risk aversion & income elasticity (Turnovsky et al., 1980, Econometrica).

16 Unpacking current policies

17 Key policies Capture the essence of discretionary policies by modeling them as simple rules. Price-insulating policies Used to insulate from changes in world prices T t M = α M P t w + θ w,i β T t X = α X P t w θ i,w β 1 + β is the level of price transmission Purchase to defend the Minimum support price: ΔS t G+ 0 P t i MSP 0. The MSP assumed to be equal to the steady-state price

18 Stockholding policy Releases to supply the PDS: ΔS t G = min Θ, S t G + ΔS t G+. If stock levels are not enough, PDS is supplied by open-market purchases. When stocks exceeds the level S G = 25 million tons, they are exported (possibly with a subsidy) X t S G = max 0, S t G + ΔS t G+ ΔS t G S G. Public stock level is an additional state variable: S G G t = S t 1 + ΔS G+ t 1 ΔS G S t 1 X G t 1.

19 Parameter Values Parameter Value India s Demand Elasticity -0.3 ROW Demand Elasticity Wheat budget share % 10 Supply Elasticity 0.2 Private Storage Cost per ton $22 Public Storage Cost per ton (source: FCI) $87 Trade Costs per ton - Import $65 -Export $35 Standard deviation of production shocks in India and in ROW % 3.5

20 Estimating trade insulation Neglecting trade costs and assuming trade: P i = αp w 1+β. Prices likely cointegrated, so estimation in level would capture their long-run dynamics, not short-run price insulation. Estimate using an error-correction model β =

21 Solution methods Rational expectations storage models do not have closed form solutions. The solution is approximated by numerical methods Projection methods: grid of points on state variables on which the model has to hold exactly. Spline interpolation between grid points. RECS solver (

22 Impacts on welfare Laissezfaire policy policy Trade Storage Both Δ Mean price% Price CV (%) Ave. Public storage Ave. Private storage RoW Price CV (%) Contributions to India's Welfare (% of consumption expense) Cons Surplus Prod Surplus Storage cost Trade cost Reduction in volatility cost Total India welfare

23 Impacts of optimal policies & optimal simple rules

24 Fully optimal Policies Identify an active policy to maximize welfare Model chooses trade tax & public storage levels State-contingent policies (depend on current availability in the 2 regions and on history of the states: policies under commitment). Analyze for different degrees of preference for price stability Allow to identify the best policy options, but Very complex policies Policies are function of variables that are not observable (e.g., Lagrange multipliers).

25 Optimal simple rules Compare with Simple and potentially more tractable rules for policy Rules of public behavior with simple feedback between observables and interventions. Optimal: rules parameter are determined to maximize welfare Optimal Simple Rules: Degree of Price insulation (β < 0: % of insulation) Constant subsidy to private storage (ζ: % of physical storage costs) Public storage costs too high; cannot justify a storage policy. Provide incentives to more cost-effective private storers.

26 Key impacts, R ν = 6 Laissezfaire Optimal Policy Simple Rules Current Policies Δ Mean price% Price CV % Average Storage RoW Price CV % Contributions to India's Welfare (% of consumption expense) Consumer Surplus Producer Surplus Storage cost Trade cost Reduction in volatility cost Total India welfare

27 Optimal policies vs simple rules R ν Share of total welfare achieved by optimal simple rules % % % % % Optimal simple rules achieves less welfare gains when R ν = 0: Gains come from terms-of-trade manipulation. OSR are not designed for this.

28 Optimal simple rules as R R ν Variables Price insulation (β) Storage subsidy (ζ) Δ Mean price % Price CV (%) Ave Private Storage Contributions to India's Welfare (% of consumption expense) Consumer Surplus Producer Surplus Storage cost Trade cost Reduction in volatility cost Total India welfare

29 With high storage costs? Previous results based private storage costs. Optimal policies with current public costs (4x)? Annual cost of storage = 61% of steady-state price. Optimal simple rule implies negligible levels of stocks Better to let annual stocks be carried out in the RoW and to use trade policy to stabilize domestic market.

30 Conclusions Current policies yield very stable domestic prices But at very high costs & potential fiscal risks Question whether costs commensurate with benefits High cost of public storage a challenge Instruments appropriate but can be used more costeffectively Adopt a more rules based policy Optimal policies could yield significant welfare gains With smaller increase in RoW price volatility Simple rules-based approaches may yield benefits almost as large as optimal policies But would require trust with private storers

31 Thank you!

32 Error correction model Variable Constant Trend Price ADF test Long-run equilibrium: ln P i t = (0.525) j-r²: (0.092) ln P t w, Ad India (1) (1) US (2) (1) Price differential India -5.24*** (1) -5.57*** (1) US -4.85*** (1) -4.79*** (1) Residual from cointegration eq ** (1) -4.00* (1) Error-correction model: Δln P i t = (0.019) (0.106) EC t 1 (0.080) Adj-R²: 0.11; DW: So β = Δ ln P t w Data: India: Annual producer prices from FAOSTAT, converted to US dollars. World: US prices (IMF) Converted to real terms using US CPI.

33 Separating instruments R ν Variables Optimal trade policy (when ζ = 0) Price insulation (β) India price CV (%) RoW price CV (%) Optimal storage policy (when β = 0) Storage subsidy (ζ) India price CV (%) RoW price CV (%)