MSP and Other Interventions in Wheat Market Are they Contributing to the Buffer Stock Cycles and Market Destabilization?

Transcription

1 MSP and Other Interventions in Wheat Market Are they Contributing to the Buffer Stock Cycles and Market Destabilization? Ramesh Chand Adoption of the green revolution technology helped India accelerate the growth in wheat production which in turn helped in reducing the heavy dependence on wheat imports to meet the domestic demand. However, the growth in production was never large enough to meet the domestic demand on a sustained basis. While most of the times the wheat production fell short of the demand, in some years the production exceeded the effective demand. Because of this, imbalances in domestic demand and supply of wheat are a recurrent phenomenon. Since these imbalances create serious problems for producers and consumers, and also for the market stability, the government has been intervening actively to stabilize the wheat market. Such interventions have been in various forms like - public procurement, guaranteed price to the producers, open market sales, maintenance of buffer stock, public distribution system, tariffs, export, import and trade regulations. However, these interventions typically have several other goals besides market stabilization. These demand and supply imbalances in the case of wheat have become more serious in the recent period, which is a cause of concern. This is indicated by the increase in fluctuations in the net trade of wheat, and from the stock held by public agencies (Fig.1 and 2). After 1998, India was caught in a spiral of accumulation of large stock of wheat, followed by large exports, and the subsequent depletion of stock followed by large imports. Again the country started building stock of wheat beginning with July 2008 and it seems to be at a threshold of accumulating the large stock. Why is this cycle repetitious and its magnitude getting aggravated? How do public interventions in the wheat market affect these cycles and the imbalances? Is there a need to change the policy of intervention in food market to improve market stability? What are the alternative options for maintaining the demand and supply balance in a better way? This paper makes an attempt to address these questions. I The Buffer Stock Cycles Until the year 1998, the level of wheat stock held by public agencies in India in an agricultural year fluctuated between16.2 million tonne (mt) and 4.2 mt (Table 1). These extremes remained within the range of + 60% of the minimum buffer stock norm for wheat, which was about 10 mt. The stock levels started rising beyond the historic peak after As against the norm of 9.6 mt average, the wheat stock reached 18.3 mt in the agricultural year and went up to 33.5 mt ICAR National Professor, National Centre for Agricultural Economics and Policy Research, New Delhi. 1

2 during the year The Wheat stock with government reached 41.4 mt on 1 st July, 2002, which was more than half of the total wheat production in the country during that year. Obviously these stocks put a heavy burden on the state exchequer and they were brought down through subsidized exports which invited a lot of criticism of the government policy (Chand 2005). Indian wheat exports reached record levels during the period to Based on these high stocks a sense of complacence developed in some quarters about the food situation in the country, and there was a talk of India becoming a surplus wheat producer. However, this euphoria was very short lived as the level of stock during the year dwindled to less than half of what it was during the preceding two years. After April 1, 2005, the buffer stock with the government declined beyond the minimum norm for the country. By April 2006, the buffer stock of wheat reached 2 mt which was half of the norm and the lowest in the last three decades. This forced the country to import wheat during , which incidentally was the largest import of wheat after The imports continued through the year Table 1: Buffer stock of wheat in different years (million tonnes) Year 1st January 1st April 1st July 1st October Average for agri Year

3 * 19.4 Norm Source: Bulletin on Food Statistics, GOI, New Delhi, various Issues Economic Survey, GOI, New Delhi various issues. * Press release, January 23, 2009, Press Information Bureau, GoI. The sudden change in the wheat situation from large exports to large imports raised several issues and questions. The average price fetched by wheat export during to varied between Rs. 479 to Rs. 747 per quintal as against average price of Rs. 962 paid for import during and Rs during As there was a whopping difference between the price paid for import and the price earned from the export (Rs. 215 per quintal between and and Rs. 724 between and ), it was argued that some stock should have been carried forward to meet a future contingency instead of exporting it at a cheap and subsidised rate. The story of the buffer stock cycle did not stop here. The wheat stock again suddenly shot up to 24.4 mt on 1 st July, 2008 and to 22 mt on 1 st October, 2008 which are approximately the double of stock levels on the same dates in the preceding year. The average level of stock during the agriculture year is estimated to be more than double the norm. The latest situation of stock as on 1 January, 2009 was 18.2 mt and the government may end up with more than 14 mt wheat stock on 1 April, 2009 against the norm of 4 mt. If the wheat output turns out to be close to the normal levels, the prevailing market situation is likely to compel the government to go for large scale procurement of wheat, as the private sector would not find it very attractive to buy wheat at the MSP announced by the government. This would then take the buffer stock closer to the levels seen during 2001 to With the International prices of wheat on a downward trend and lower than the MSP, the export window for reducing level of stock is almost closed. If the country chooses to provide subsidy to wheat to reduce the stock, as done during , it would amount to subsidizing foreign consumers at the cost of tax payers of India while depriving domestic consumers. The moot point now is why buffer stock cycles have become so serious during last 10 years, and can something be done to moderate them and restore the balance between demand and supply. In order to explore this we need to examine the government intervention in wheat market mainly through the MSP, which is attempted in the next section. 3

4 Fig. 1: Average stock of wheat with public agencies, 1981 to 2009, million tonne Fig. 2: Net trade in wheat (export-import) to , million tonne Fig. 3: MSP and Cost of production of wheat deflated by CPIAL, to

5 II Minimum Support Prices The distinction between the MSP and procurement price was abolished long back and the government now procures foodgrains at the MSP only. This implies that the MSP serves two purposes (a) a check against the price falling below the floor level and (b) meeting the procurement target determined by the government. As the government purchases a significant quantity of wheat in the wheat harvest season, the level of MSP has very strong influence on the level of open market price not only in the harvest season but in whole of the year. Therefore, the MSP also strongly influences the scale of operations of private sector in the market. The common perception about MSP is that it is fixed based on the level of cost of production. A lot of debate has gone into this aspect and over time some new items have been added to the cost concept that should be considered in the determination of the MSP. In the cost of cultivation parlance, C2 cost is considered as a relevant concept for the MSP. This cost includes all actual expenses in cash and kind, rent for leased in land, and imputed values of the cost of family labour, owned capital assets, depreciation, the interest on fixed and variable capital, the rent for owned. A fairly large percentage of this cost is in fact return to the producers. The MSP based on the cost of production has two big advantages. One, it ensures that the producers do not suffer a loss and they get a price that is remunerative. Two, the cost of production also captures the market trend to the extent this trend is reflected in the wage rate and the input prices. As per its terms of reference the CACP takes into account several factors, apart from the cost of production, in formulating the recommendations with respect to the level of MSP. These include price parity, demand and supply, the effect on the industrial cost structure and the cost of living, the international price situation, the effect on issue prices and the implication for food subsidy. 5

6 It would be interesting to see the level of MSP relative to COP, and how the two series have moved over time. Till the year 1998, the level of MSP remained very close to what the cost of production of wheat was. Mostly, the MSP stayed slightly higher, but occasionally it went slightly lower than the COP. 1 However, after 1998 MSP for wheat started deviating from COP in upward direction and large gap developed between the two (Fig. 3). The correlation coefficient between the cost of production and the MSP of wheat normalized by the Consumers Price Index for Agricultural Labour (CPIAL) was 0.62 during to and it declined to 0.12 after , which was non significant. In the same periods the correlation between domestic and international price of wheat (US HRW wheat FOB price) expressed in US$ increased from 0.27 to Juxtaposing Fig 3 on Fig. 2 and Fig. 1, shows that as long as the MSP was anchored to the COP, the buffer stock and the net trade in wheat followed a relatively mild year to year fluctuations (refer to period to ). The periods during which the MSP for wheat deviated from the COP, the buffer stock cycles and trade cycles became violent. In other words, as long as the MSP was kept close to the COP, fluctuations in the buffer stock and the net trade of wheat remained mild, but when the MSP started rising above the COP, then the imbalance in demand and supply became acute. It is important to explore why the MSP became almost independent of the cost of production after The reason for this seems to be that around the year 1996 i.e. immediately after WTO, the government was under a strong pressure to bring a parity between domestic and international prices. As the international prices of wheat during 1995 and 1996 were on a boom and much higher than the domestic prices (Table 2), various farm groups and even researchers started pleading for aligning the domestic prices with the global prices by paying the farmers higher prices. In this environment, the government raised MSP for wheat marketing year 1997 by 25%, from Rs. 380 to Rs. 475 per quintal, even though the increase in the MSP recommended by CACP was only Rs. 25. Over the next two years i.e. for 1998 and 1999, CACP raised its recommendation by 21% and the government further raised the effective MSP by more than 12% of what was recommended by CACP. After the year 1996, the international prices started moving downwards. The net result was that by the year 1999 the MSP for wheat turned out to be much higher than what was the international price. While the international price was declining, the CACP recommended a rise in the MSP from Rs. 490 for the year 1999 to Rs. 580 for the year The country had already started accumulating larger than the required stock of wheat in 1999, and the stock level further increased to more than double the minimum norm by October In the light of a built up of the surplus stock, and the domestic and international price 1 COP is not known at the time of announcement of MSP. CACP uses projected cost based on input price trend to get estimate of COP in the next year for which MSP is announced. Beside other factor, variation in yield is a major factor for change per unit cost compared to projected COP. Thus MSP cannot be exactly anchored to COP and some deviation between MSP and COP is obvious if MSP is fixed based on COP. 6

7 situation, the CACP recommended in its report for the crop year that since the present MSP was already too high the commission did not make any recommendation for wheat (CACP 2001, p.445). Despite this recommendation, the government revised the MSP upwards by 5%. 7

8 Table 2 : MSP, Cost of production and international price of wheat, Rupeees/quintal Year MSP Recommended by CACP MSP announced by government including bonus Bonus International price FOB US HRW wheat# Cost of production for Punjab NR Source: Reports of the Commission for Agricultural Costs and Prices, various issues, Commission of Agricultural Costs and Prices, Ministry of Agriculture, GoI, New Delhi. Agricultural Statistics at a Glance, GOI, various issues. # Taken from IMF data base on prices and multiplied by the exchange rate taken from RBI. A critical examination of the year by year change in the MSP and the international prices presented in Table 2 and Fig. 4 shows that after 1995, the MSP was clearly raised when the international prices were higher than the domestic prices however, the MSP was not lowered 8

9 when the international prices fell below the domestic prices and the MSP. This closed the trade window to stabilize the domestic market through exports when there was surplus wheat in the country. The increase in MSP while ignoring the COP and the domestic market conditions also adversely affected the domestic demand and led to a buildup of stock with the government. This buildup of stock was not due to an increase in production, since per capita production of wheat was lower in these years compared to the past (Chand 2007a, Fig. 2 p. 1661). Contrarily, the buildup of wheat stock led to sharp decline in per capita availability of cereals which had an adverse impact on the domestic consumption and nutrition (Chand 2005; Chand and Kumar 2006). As the level of stock became unsustainable due to the financial burden associated with carrying these stocks, the government had to adopt desperate measures like export subsidy to get rid of the excessive stock. This led to a concentration of exports in a few years rather than a distribution of exports over a longer period. Fig. 4: MSP and international price of US HRW wheat, $/quintal The cycle in the wheat market seems to have reappeared in the country. 2 The international prices of wheat and other food items started showing a dramatic increase after Once again there 2 This time private sector also played a role in addition to government in transmitting increases in international price to domestic market. In order to pave the way for increased participation of private sector in foodgrain market the Central Government issued the Removal of Licensing requirements, Stock limits and Movement Restrictions on Specified Foodstuffs Order, 2002 on 15 February 2002, allowing dealers to freely buy, stock, sell, transport, distribute, dispose, etc., any quantity in respect of wheat, paddy/rice, coarse grains, sugar, edible oilseeds and edible oils without requiring any license or permit therefore under any order issued under the Act. This was follow by launching of future s trading in wheat and rice in year Another important step taken up by the Central government and various state government was to adopt Model APMC Act which facilitated direct contract between buyer (trading firm/processor, exporter) and producers/farmers for purchase of produce, known as Contract farming. Private sector responded to these changes in a big way and many large business firms like ITC, Cargill, Australian Wheat Board, Britannia, AgroCon entered wheat and rice market in the country. A large number of other trading 9

10 was a strong pressure on the government from several quarters to maintain parity between the domestic and the international prices on the grounds of fair treatment to the country s farmers. There was also an urgency to replenish the low level of the buffer stock. Thus, to ensure sufficient procurement, government raised MSP by 21% for the year The wheat prices in the international market reached a level of Rs per quintal towards December This time the CACP raised the MSP from Rs. 750/quintal for the year 2007 to Rs for the year 2008, an increase of 33% in one year. This was almost 50% higher than the COP. The MSP recommended by CACP was so high that it left little scope for the government to raise it further or to give a bonus on the MSP. Except the high level of the international prices there was no justification for CACP to recommend such a big hike in the MSP. 3 This permanently shifted the MSP upward on a new trend. When the time came to announce the MSP for the year 2009, the international prices of wheat after crossing a peak of the new cycles in mid 2008, had started moving towards a new trough. Price of the US HRW wheat (FOB at US Gulf ports) declined from US $ 308 to $272 per tonne between the second halves of 2007 and Domestic inflation also slowed down to 6 per cent level by the end of The government was holding stock in excess of the norm and the domestic demand did not support any further increase in the MSP. The market was not even absorbing the price based on the MSP of Rs in the current year. All these factors necessitated moderation or at least freeze in the MSP hikes. However, ignoring all such factors the CACP has recommended an eight percent increase in the MSP for the year The available indicators suggest that the domestic demand is unlikely to absorb the increase in wheat price and the demand-supply imbalance which emerged in 2008 may get exacerbated in the year III Distortions Caused by use of MSP as Procurement Price houses and business firms started trading in spot market and future s market in rice and wheat; more actively in future s trading. These activities of private trade made wheat prices in India to move in tandem with CBOT prices and created abnormal conditions in wheat market; wholesale prices were rising in post harvest weeks in 2006 (Chand 2007b) and prices went out of the control. In the middle of procurement season in 2006 government announced bonus of Rs. 50 on MSP for wheat but private sector offered higher prices, consistent with international prices, and government could not procure required quantity of wheat. This brought government stocks to terribly low level and wheat market during the entire year remained in a tail-spin situation. Wholesale price of wheat in Delhi market increased by more than 50% between April and November. This forced the government to bring back restrictions on private trade, and, future trading in wheat and rice was also banned in February CACP recommendation on paddy price for the year 2008 was much more appalling. The commission recommended MSP of Rs for paddy for the year which involved 54% hike over the previous year. Such high increase left the government bewildered. This had put the credibility of CACP under question as government referred the recommendation on paddy MSP to another expert body. Finally, government announced MSP of Rs. 850 for paddy which was Rs. 150 lower than the MSP for paddy recommended by CACP. Probably it was for the first time since the creation of Price Commission that government lowered the MSP recommended by the Commission. 10

11 When the MSP is used as a procurement price to meet the procurement target, it implies that the open market price would be forced to remain at the level of the MSP during the procurement period. However, the demand and supply situation in a given period may not lead to a price equilibrium that exactly corresponds to the MSP. Thus, when open market price deviates from the MSP, the procurement at MSP introduces immediate distortions in the market. The second type of distortion by the MSP follows from the year to year change in the MSP. It has become an established norm in the country to either raise the MSP each year or leave it unchanged. A situation may arise when open market prices are very high and procurement is not possible if the price for the output is not raised substantially, for instance year 2006, 2007 and 2008 for wheat market. Similarly, global factors under liberalized trade regime may also necessitate big hikes in domestic price, like the wheat situation in However, after some time when the situation reverses, it cannot be reflected in the domestic procurement price if these prices are not lowered. Thus, increasing the MSP/procurement price or keeping it at the same level when the market forces actually require that it be lowered, brings the second serious distortion in the market. As the economy is opened to the outside world and controls on the domestic market are relaxed, open market prices are going to fluctuate. Procurement by official agencies at MSP in this kind of situation is going to produce serious imbalances in demand and supply as witnessed in the wheat market during the last ten years. This problem can be addressed by drawing a clear distinction between the two types of prices, one meant for safeguarding the interest of farmers against prices falling below the level that is not remunerative, and the other meant for meeting procurement targets and ensuring market stability. Use of bonus in addition to the MSP, as a mechanism to address this kind of situation has failed completely. In practice, the MSP announced by the government has never been lower than MSP plus bonus in any of the preceding years. 4 Changes in the MSP in response to the market conditions and the international price situation in the last decade, have moved only in one direction, that is upwards. This price has never been adjusted downward when there was sharp fall in international price or domestic open market price. This asymmetric adjustment in the MSP to factors other than the COP also caused an adverse effect on food availability and food subsidy. Because of the unidirectional change in the MSP, a bumper production of wheat added to nation s woes, and ironically reduced the availability of wheat for domestic consumers. India harvested record production of wheat during 2008 (78.4 mt) out of which 7.1 mt went to accretion of stock between 1 st April, 2009 and 1 st April, This left only 71.3 mt available for domestic use. In contrast to this, 74.7 mt wheat was available in the domestic market during when production was 75.8 mt. A similar situation was faced during the previous peak of wheat production in the year Out of the total production of 76.4 mt in 2000, 8.3 mt ended up as a net addition to the government stock, 4 CACP recommended MSP for wheat in and which was lower than MSP plus bonus in the previous years but it was raised by government to the level higher than MSP plus bonus in the previous year. Thus, in practice bonus has lost its significance to keep effective MSP flexible for downward revision. 11

12 leaving 68.1 mt for the domestic supply during This shows that a bumper production of wheat renders less wheat available for the domestic consumers, and increase in production resulted simply in swelling the buffer stock. The primary reason for this is that bumper production coincided with high market prices induced by the MSP. Another adverse consequence of the MSP being higher than the open market price is that the farmers in the regions where the government does not procure produce, get a lower price because private sector finds it more profitable to buy wheat released through OMSS by the government than buying the wheat from farmers at a price close to the MSP (Chand 2005, Table 11 p. 1061). It is thus concluded that unidirectional revisions in the MSP create serious demand and supply imbalances, and the buffer stock cycles. Additionally, they lead to reduced availability of food and an increased burden on the state exchequer. There is thus a strong need to devise a system of price intervention that provides incentives to producers without causing distortions in the market. IV Likely Wheat Scenario During Like the scene witnessed during 2001 to 2003, the hike in the MSP for the year 2008 has not been absorbed by domestic demand. Stock levels have already gone much higher than the norm and are putting a strain on the storage capacity of the government. The government is trying to dispose off some stock of wheat through open market sales at a price much lower than the economic cost of wheat to FCI. The reserve price for OMSS in the tender floated by FCI on for the period upto February 2009 was fixed at Rs per quintal. This involved heavy loss to FCI/government on the sale of wheat purchased at MSP of Rs The prospects of any buyer buying wheat under OMSS even at a subsidized rate remained poor as the open market price was lower than the OMSS price in most of the regions of the country. According to the second advance estimate released on 12 February, 2009, wheat output in the country is forecast at 77.8 mt, which is marginally lower than the output of the last year. However, weather parameters so far indicate that the output would be lower. The global output of wheat during is projected to be 11% higher (at 688 mt) than the previous year but the forecast for 2009/10 is slightly lower. With the global production of wheat at 688 mt during , the global wheat stock is projected to be approximately 50 mt. With this level of stock, the global wheat prices would not be under any pressure to rise during The major wheat exporting countries are offering to sell wheat at a price far lower than what is the MSP of wheat in India. If India wants to export wheat, the FOB price at Indian ports would be more than Rs. 5 In Punjab, which contributes more than 50% to Central pool of wheat, acquisition cost of wheat corresponding to MSP of Rs turns out to be Rs Thus economic cost to FCI to release this wheat in a nearby market like Delhi in January 2009 would be more than Rs

13 1400 per quintal corresponding to the MSP in Punjab. Presently, this price is about 50% higher than what is being offered by the other countries for comparable quality of wheat. Thus, the export option to liquidate stock, without some sort of financial assistance, is completely ruled out. Coming to the domestic market, the open market prices of wheat do not show any strong undercurrent for price increase 6 in any of the major markets in the country. If the production of wheat turns out to be close to the second advance estimate then there would not be much pressure from demand side on the prices. In this kind of a situation, the private sector may not find it profitable to buy wheat at the MSP in surplus states like Punjab, and sell it in distant deficit states. The states of Haryana and Punjab levy more than 10% taxes on wheat purchase which are among the highest in the country. It would be in the interest of the private sector to buy wheat from those regions where the government does not procure wheat. This would imply lower transportation costs to the deficit areas, and also allow the private players to purchase wheat at a price lower than the MSP 7. All these factors are likely to force the public agencies to procure most of the wheat that arrives in the markets of states like Punjab, Haryana, Western U.P. and Rajasthan. This would take buffer stock of wheat to a very high level by July 2009, somewhat similar to the situation witnessed in the year 2000, and is likely to cause a serious concern to the country. One may be tempted to suggest that the excess of stock over the current requirement should be carried forward to meet any eventuality of high wheat prices that may arise in 2-3 years from now. However, there is a capacity constraint on the safe storage of foodgrains. The government is now caught in a very difficult situation in liquidating wheat stock and in avoiding wheat procurement beyond the required level during It may be worthwhile to incentivise private traders to buy more wheat this season by meeting some costs like market taxes, or the cost of gunny bags by the government, rather than taking a desperate measure at a later stage, like export subsidy to dispose of excessive stock. Wheat production in year 2009 is also likely to be lower than the official estimate which would also help the government to go for lower procurement. V Policy Suggestions Price intervention by the government in a liberalized market regime necessitates that the intervention price is kept flexible and is allowed to move up as well down in response to the 6 Wheat price in Delhi market during January-February 2009 was 5.8% percent higher than corresponding period in 2008 and WPI for wheat show inflation of 5% in January These rates of increase in domestic prices are lower than the rise given to MSP for the year Moreover, restrictions imposed on private trade and ban on wheat export imposed in 2006 and 2007 have not been removed. 13

14 changes in the market conditions. The need for keeping the intervention flexible is reinforced by the fact that the global shocks are becoming increasingly frequent, severe and unpredictable. This can be done in two ways. The simplest way is to revise the MSP up or down every year while ensuring that the MSP remains higher than the COP. However, the way this concept has been used for a long time, the change would be unpalatable to farmers and politically unacceptable. A better and more sophisticated option is to maintain a clear distinction between the MSP and the procurement price (PP). Under this dispensation, the MSP should be announced before the commencement of the sowing season and serve as a guarantee to the farmers against fall in the price below a threshold level. CACP should also be asked to give recommendation on PP considering the domestic and international market situation. This price (PP) should be at all times kept above the MSP, and it should be adjusted upward or downward depending upon the situation. The PP recommended by CACP should be used as a benchmark for foodgrain procurement by the government. A Cell in the Ministry of Food should monitor the prices regularly, and if need be, change the PP upward or downward periodically (each week or day), depending upon the market situation. In thsis age of communication there should not be a problem in communicating to the government agencies field staff about the day to day changes in the procurement prices. If the market price falls below the threshold level, the government should procure the entire grain offered for sale, at the MSP. Carrying the buffer stock to counter production cycles and stabilize the market could be a better option than trade under high volatility in international prices. To exercise this option, the country needs to develop and expand storage capacity for food grains. This would also help the government to check distress sales and take advantage of favourable international prices. Acknowledgements I thank Amitesh Bajad for reading the draft of this paper under serious time pressure and for the valuable editing done by him. 14

15 References Chand Ramesh (2005). Whither India s Food Policy: From Food Security to Food Deprivation, Economic and Political Weekly, V.40 (12): , March 12, Chand Ramesh and P. Kumar (2006). Country Case Study India, in Harmon Thomas (ed.). Trade Reforms and Food Security, Food and Agriculture Organization of United Nations, Rome, pp Chand Ramesh (2007a). Wheat Supply, Price Prospects and Food Security, Economic and Political Weekly, V.42(19): Chand Ramesh (2007b). Wheat Import and Price Outlook for : Separating the Grain from the Chaff, Economic and Political Weekly, V.42(30):