Modus Operandi for Price Deficiency Payments and Why Price Deficiency Payments?

Modus Operandi for Price Deficiency Payments and Why Price Deficiency Payments?

This paper analyses the potential benefits of the price deficiency payments system vis-à-vis the existing MSP policy for selected crops such as rice, wheat, gram, tur (arhar) and cotton, and looks at the challenges involved in implementing the proposed system.

It also examines whether price deficiency payments will work better than the existing MSP policy to improve farm productivity and incomes, as well as help reduce the farm subsidy bill of the government. The paper is based mainly on the analysis of secondary data and review of relevant literatures.

Why Price Deficiency Payments?

• The case for price deficiency payments to farmers is made out on the ground that the existing MSP policy, which is being followed in India since 1965 for various agricultural commodities, is highly inadequate and ineffective from a farmer’s perspective and also inefficient from an economic point of view.
• First, the costs of production vary widely from region to region and the existing methodology of fixing MSPs, based on all India weighted average costs, does not necessarily guarantee remunerative prices to all farmers in all regions.
• Second, the farmers in general are unhappy with the MSP programme because the input costs in crop production have recently gone up at a faster pace than the MSPs.
• From 2004–05 to 2014–15, the average annual growth rate of C2 cost of production of paddy was 11.2% in Bihar and 11.9% in West Bengal, while the MSP of paddy increased only at the rate of 10.6% per year.
• Third, MSPs are to some extent effectively implemented only in Punjab, Haryana and Madhya Pradesh for wheat and Andhra Pradesh, Chhattisgarh, Punjab and Haryana for rice. The farmers in other states hardly benefit from MSPs as there is either a very small or no presence of government procurement agencies.

Price Deficiency Payment Scheme India

• The 70th round of National Sample Survey for 2012–13 reveals that only 32.2% of paddy farmers and 39.2% of wheat farmers in the country were aware of the MSP, while only 13.5% of paddy farmers and 16.2% of wheat farmers sold their produce to government procurement agencies (GOI 2014).
• The main reason cited for not selling to these agencies was their non-availability at the local level.
• In the case of commercial crops like cotton and jute, the Cotton Corporation of India (CCI) and Jute Corporation of India respectively intervene only when the market prices fall substantially below the MSPs. There is no effective procurement policy for coarse cereals, pulses and oil seeds.
• Also, the fair and remunerative price fixed for sugar cane generally comes in conflict with state-advised prices and is rarely implemented. Under these circumstances, a majority of the farmers in the country do not really benefit from the MSPs.
• At the same time, the MSP policy has been under attack recently by several economists. It is argued that this policy destroys the power to harness the market potential and kills efficiency (Chand 2013). Chand further argues that
• it is not feasible for public agencies to procure the marketed surplus of each and every commodity everywhere in the country to prevent prices falling below a floor level; nor would this be desirable … So, new mechanisms have to be devised to protect producers against the price falling below the threshold level. (Chand 2012)
• There are other economists who criticise the MSP policy because of its adverse impact on the gross domestic product and food price inflation (Parikh et al 2003; Bhattacharya and Sengupta 2015).
• Moreover, the union government, especially the Ministry of Finance, is worried that higher MSPs of rice and wheat, offered in the recent past, have increased the food subsidy bill. The food subsidy bill increased from ₹72,370.90 crore in 2011–12 to ₹1,05,509.41 crore in 2015–16 (GOI 2016).
• In addition, the increase in MSPs in recent years, resulting in huge procurement and public stock holding of grains, has attracted the attention of the World Trade Organization (WTO), requiring India to find a permanent solution on a best endeavour basis.
• The agricultural trade rules as outlined in the WTO Agreement on Agriculture (AoA) do not bar public stockholding programmes in developing countries for food security purposes. However, if food is procured at administered prices and not at market prices, then this is deemed support to farmers, and this cannot exceed the limit of 10% of the value of the production in question.
• Therefore, it is not surprising that the policymakers in India are trying to find an alternative mechanism, which would keep the quantum of the subsidy in check and also meet the restrictions on the subsidy imposed by the WTO.
• The main objective of the intended policy shift is to improve farmers’ incomes as well as reduce farm subsidies (GOI 2015a), whereas the objective of the MSP policy is to incentivise farmers to produce more and earn more without caring for subsidy management.

Modus Operandi for Price Deficiency Payments

• The effectiveness of price deficiency payments in either helping the government to reduce its agricultural subsidy bill or improving and stabilising farm incomes will depend on how the programme is conceptualised and operationalised.
• Although, the government has not yet clearly decided the face of the programme, one can refer to several alternative frameworks. Also, one can develop a mechanism based on the experiences of the United States (US) with countercyclical payments or Price Loss Coverage (PLC) schemes in the last several years.
• The first alternative we put forth is that price deficiency payments be based on the difference between the MSPs and farm harvest prices (FHPs).
• The government may continue to fix MSPs for 23 agricultural commodities and provide deficiency payments to farmers for all such commodities whenever the FHPs rule below the MSPs, without purchasing any quantity of the covered crops or purchasing only a limited quantity of any important crop.
• The Ramesh Chand Committee (GOI 2015b) suggested that mechanisms such as deficiency price payment or price insurance should be put in place for price surety for all the crops for which MSP is declared. This is because the MSP cannot be implemented everywhere for all crops through a system of procurement.
• The second alternative suggested is that deficiency payments should be based on the difference between the average of FHPs of the preceding three years and the fourth year price. The NITI Aayog occasional paper proposes that, under the system of price deficiency payment,

Price Deficiency Payment For Farmers

• the government would announce a floor price for each crop. This floor may be the average of the market price in the preceding three or four years. Each farmer would register his/her crop and acreage sown with the nearest APMC [agricultural produce market committee] mandi.
• If the market price falls below the floor price, the farmer would be entitled to the difference up to a maximum of, say, 10% of the assumed price that could be paid via direct benefit transfer into an Aadhaar-linked bank account. (GOI 2015a)
• Let us analyse the potential gains and drawbacks of both these propositions.
• Alternative 1: The first proposition involves basing deficiency payments on the difference between the MSPs and FHPs.
  Considering the country as a whole, the average FHPs and MSPs of paddy increased at the rate of 7.84% and 7.77% respectively during the period 1998–99 to 2014–15.
• It may be seen from Tables 1a and 1b (p 54) that the FHPs of paddy were marginally above the MSPs in 13 out of 17 years (1998–99 to 2014–15). From 2010–11 to 2014–15, the average FHP was lower than the MSP only once in 2011–12.
• In fact, the average FHP in the country from 2010–11 to 2014–15 was ₹1,296 per quintal against the average MSP of ₹1,200 per quintal. In such a case, the government does not have to make deficiency payments to farmers.
• But a difference of ₹27 per quintal in 2011–12 would have translated into a cost of ₹4,313 crore for the government based on total production, and ₹3,765 crore based on marketed surplus of paddy.
• In the case of wheat, the FHPs were higher than MSPs in most of the years during the period 1998–99 to 2014–15.
  Figures 1a, 1b, 2a and 2b show the movements of average FHPs and MSPs of paddy (rice) and wheat.
• From 2010–11 to 2014–15, the average of FHPs of wheat was ₹1,324 against the average MSP of ₹1,331. In 2011–12, however, the FHP was lower by ₹126 per quintal in which case the government would have to incur ₹11,529 crore as deficiency payment to farmers.
• If we add the differential value of ₹4,313 crore for paddy production in that year, the total amount for rice and wheat would be ₹15,842 crore based on production figure, and ₹13,818 crore based on marketed surplus.

Government Procurement And Price Deficiency

• In comparison to this, the government’s food subsidy bill due to procurement, distribution and storage of rice and wheat and the gap between their economic costs and the central issue prices worked out to ₹84,553.13 crore per year from 2010–11 to 2014–15. In 2011–12, the food subsidy bill was ₹72,370.90 crore, and in 2015–16 it was ₹1,05,509.41 crore (GOI 2016).
• Thus, the government would make a huge saving by switching to the price deficiency payment system and the farmers would get no less than the MSPs anywhere in the country.
• If the government pays only 10% of the price deficiency to farmers, the amount of average subsidy paid would be even lesser. The challenges involved in the implementation of price deficiency payments could be less in comparison to MSPs as it is not linked to procurement and distribution.
• However, the crops for which MSP has only a notional value, as it is hardly defended even if the FHPs fall below the MSP, tell a different story. In the case of tur (arhar), from 1998–99 to 2014–15, the average of FHPs remained much higher than the MSPs in 14 out of 17 years with huge differences .
• From 2010–11 to 2014–15, the average FHP of tur was ₹3,849 per quintal as against the MSP of ₹3,490 per quintal. In 2011–12, the FHP, however, was as low as ₹3,169 per quintal against the MSP of ₹3,700 per quintal, that is, a difference of ₹531 per quintal.
• In this case, for a production of ₹2.65 million tonne, the government would need to pay ₹1,407.15 crore to the tur growers as deficiency payment. This would amount to ₹1,146.96 crore for the tur sold.
• In reality, the government paid nothing to the farmers; therefore, deficiency payments would mean a net loss of revenue for the government and a gain for the farmers.
• Similarly, in the case of gram, another important pulse crop, the average of FHPs in the country was higher than the MSPs in 14 out of 17 years (1998–99 to 2014–15). Figures 2a and 2b show the temporal variations in average FHPs of tur (arhar) and gram.
• From 2010–11 to 2014–15, the average of FHPs of gram was ₹3,070 against the average MSP of ₹2,835 per quintal. In 2013–14, the average of FHPs of gram in the country was ₹3,049 against the MSP of ₹3,100, that is, less by ₹51 per quintal.
• If the government had to make deficiency payments to the farmers growing gram, the required amount would be about ₹486.03 crore based on production, and ₹407 crore based on marketed surplus of gram in that year. Since gram is not procured by the government, this would be a net revenue loss for the government and net gain for the farmers.
• In the case of cotton, a commercial crop for which there is now an attempt to pilot the system of price deficiency payment, the average of FHPs remained lower than the MSPs in 10 out of 14 years (2001–02 to 2014–15) (Figure 3, Tables 1a, 1b).
• The year-to-year movement of FHP and MSP of cotton is shown in Figure 3. Since, the FHP of cotton was generally lower than the MSP in most of the years, the deficiency payment would hugely benefit the farmers and cause a revenue loss to the government.
• In 2012–13, when the price differential was as much as ₹324 per quintal, the CCI purchased only 392 thousand tonnes of cotton at MSPs out of 34.2 million tonnes of total production.
• The marketed surplus constituted nearly 99% to 100% in the case of cotton; therefore, the MSPs covered only a fraction of the total quantity marketed and the farmers did not benefit much from the MSPs.
• Also, the cotton procurement by the CCI was concentrated mainly in Andhra Pradesh and to a small extent in Maharashtra, Odisha, Rajasthan, Punjab and Karnataka. The cotton farmers in Tamil Nadu, Gujarat and Madhya Pradesh did not benefit much from the cotton purchase operation of the CCI.
• Thus, the farmers in general would benefit immensely if a system of price deficiency payment, using the differential between MSP and FHP, is implemented. At the same time, the government can also reduce its food subsidy bill on rice and wheat.
• Alternative 2: The second proposition involves basing deficiency payments on the difference between the previous three-yearly average price and the fourth year price. If the MSP is rejected as the target or reference price, and the average of past three years FHPs is considered as the reference price, the situation looks more or less similar.

Government Procurement And Price Deficiency

• It can be seen from Figures 4a and 4b (p 57) that the average price of paddy as well as wheat in every fourth year through 2000–01 to 2014–15 was higher than the previous three-yearly average price; therefore, the government does not have to make any deficiency payment to farmers.
• In the case of cotton also, the FHP in every fourth year during the period 2004–05 to 2014–15 was higher than the previous three years’ average price in almost all cases; therefore, the government would not have to make any deficiency payment (Figure 5, p 58).
• In the case of tur, the government would have had to make a small deficiency payment in 2004–05 and 2011–12 and for gram in 2003–04. But, the farmers would have gained because normally they do not receive this kind of benefit, as there is no effective market intervention by the government for pulses.
• Relatively speaking, Alternative 1 seems to be more beneficial to the farmers and Alternative 2 to the government. But, all in all, both the government and farmers in general would be better off switching from the present MSP regime to price deficiency payment system, using both Alternatives 1 and 2.

Production Impact

• The role of MSPs in augmenting crop production in India has changed over time.
• While the price support along with high-yielding variety (HYV) technology played an important role in raising the production of rice and wheat during the 1970s and 1980s (the green revolution period), the supply response to price change has weakened over time.
• According to Vaidyanathan (2010), non-price factors, namely input, technology and institutions, play a fundamental and dominant role in agricultural growth.
• The result of a log linear regression analysis (Table 2) further shows that during the period 1998–99 to 2013–14, MSP significantly influenced output only in the case of wheat.

Price Deficiency Payment For Farmers

• For rice, the output response to changes in MSP was positive but statistically non-significant; whereas for cotton and gram, the impact was positive albeit statistically non-significant. For tur, the impact was negative but statistically non-significant.
• The role of irrigation was found to be positive only in the case of rice and cotton. Besides, the role of technology was positive and significant in raising the cotton production. As against this, price deficiency payment, not linked to current production and prices, is not supposed to have any effect on production.
• But, in reality, such payments indirectly result in reducing the price risk and increasing the incomes of participating farmers and, consequently, their ability to invest more and enhance output.
• Although this has yet to be demonstrated in practice and evaluated, a recent study suggests that switching from MSP to deficiency subsidies would be less distortive and less costly, without affecting the output adversely (Kozicka et al 2015).

Regional Variations

• However, if region-specific price deficiency payment mechanism is followed, the farmers in different regions would either benefit or lose differently due to regional variations in the pattern of temporal changes in prices.
• If we adopt MSP as the reference or target price, that is Alternative 1, the difference between FHP and MSP is quite frequent and large in several states in respect of the selected crops. In the case of paddy, the FHPs remained generally lower than the MSP in Bihar, but in Punjab it was higher than the farm harvest prices in most of the years (Tables 3a, 3b, p 58).
• The paddy growers in Bihar would be entitled to deficiency payment, but not those in Punjab. Wheat farmers in both Bihar and Punjab would benefit from deficiency payment based on Alternative 1, but those in Madhya Pradesh would not.
• In Tamil Nadu and West Bengal, the two prices remained largely close to each other. For wheat, the FHPs were mostly lower than MSPs in Bihar and Punjab, and therefore farmers in both these states would gain by way of deficiency payments.
• But, it was higher than the MSP in Madhya Pradesh. Therefore, wheat growers in Madhya Pradesh would not be eligible for deficiency payment as the FHP was higher than the MSP.
• In the case of cotton and gram, FHPs were higher than MSPs in most states in many of the years during the period 1998–99 to 2014–15. But, for tur, the FHPs were higher than MSPs between 1998–99 and 2009–10; however, these remained lower than the MSPs thereafter.

Price Deficiency Payment For Farmers

• In other words, the MSP of tur has been ruling higher than the FHPs in the past few years. So, the tur growers may not benefit from the deficiency payment principle; although in reality, all tur and gram cultivators on the whole shall benefit as presently there is no effective implementation of MSP in the country. Even if one considers Alternative 2, farmers might be better off.
• Table 4a through Table 4e (pp 59, 60) show the variations in FHPs in important states over time in respect of selected crops. It can be seen from Table 4a that in Andhra Pradesh the FHP of paddy in every fourth year was higher than the previous three-yearly average price, so no deficiency payment would be required.
• But, in the case of Punjab and Haryana, the fourth year price was lower than the previous three years’ average price in five out of 14 years considered . In other states, the fourth year FHP of paddy was lower than the three-yearly average price in at least two to four years.
• Similarly, in the case of wheat, no deficiency payment to farmers in Bihar, Gujarat, Haryana, Rajasthan and Maharashtra was required as the FHP in every fourth year was higher than the previous three-yearly average price.
• But, in Punjab, Madhya Pradesh, Uttar Pradesh and West Bengal, deficiency payment would have had to be made. In Punjab, the fourth year price was lower than the previous three years average price only twice in 14 years, while it was thrice in West Bengal .
• In the case of cotton, almost all states had some cyclical variation in FHPs and, therefore, the government would have had to pay the deficiency in prices. In the case of both tur and gram, almost all states except Bihar had witnessed deficiencies in the two prices in the fourth year and, therefore, the government would have had to incur a net loss of revenue, while the farmers would gain.
• The overall emerging scenario suggests that both government and farmers would be better off switching to the price deficiency payment mechanism from the present MSP system, irrespective of whether Alternative 1 or Alternative 2 is followed.

Key Challenges

• It becomes clear from the above discussion that the price deficiency payment system may be a better choice over MSP for both farmers and the government under certain conditions. However, there would be several challenges in the effective implementation of price deficiency payment system.
• First, if centrally fixed MSPs do not benefit farmers of all regions equally, as the costs of production vary from region to region, price deficiency payments, based on one national reference price, could be unequal too because the farm harvest prices also vary from state to state.
• Second, if the MSP system is criticised because of high programme costs, the price deficiency payment may be equally vulnerable on that count.
• In years when production of selected crops is high, market clearing prices may be pushed to very low levels and deficiency payments and, consequently, farm subsidy would increase (Russo 2007).
• The programme costs can be reduced to some extent by limiting payments up to 10% of the price difference, as the NITI Aayog paper indicates; however, this may or may not be politically feasible.
• Third, in an unregulated market, middlemen can create an artificial shortage or glut in order to increase their profits. In the presence of middlemen and traders, holding market power, the effects of price deficiency payments on either government subsidy or farmers’ welfare would be uncertain.

Price Deficiency Payment Scheme India

• Fourth, if the price deficiency payment programme is adopted, the government may stipulate to either scrap or phase out the food procurement programme and make the deficiency payment to farmers via direct benefit transfer into their Aadhaar-linked bank account.
• Once this happens, the procurement-based MSP will die a natural death. However, the real value of cash transfers may get eroded in a period of rising prices (Ghosh 2011).
• Fifth, there would be problem in the implementation of price deficiency payments through Aadhaar-linked land record and bank accounts because a large number of farmers do not have either of these. Also, informal tenants, who benefit from the MSP currently, would fail to benefit from any price deficiency payment.
• Sixth, in the absence of MSP based procurement of grains such as rice and wheat, farm market prices may fall. Hence, the gap between any statutorily fixed reference price and the FHP may be quite large, causing a loss to the government exchequer in terms of price deficiency payments.
• Seventh, farmers may view the price deficiency payments as a risk reducing income hedge and may not fully respond to market signals.
• Eighth, price deficiency payments linked to current production would affect farmers’ current production decisions and, therefore, would be questioned for being market distorting.
• Hence, the deficiency payments should be decoupled from current production and appropriately linked to fixed proportion of any past level of production. As a matter of fact, decoupled payments would also influence farmers’ wealth, risks and crop choice, although such influence could be lower than that of coupled payments (Bhaskar and Beghin 2007).
• Finally, another point to consider is that price deficiency payments in the US have shown mixed results. The countercyclical payments under the Farm Security and Rural Investment Act of 2002 and the PLC under the Agricultural Act of 2014 have posed many challenges.
• The PLC protects the farmers of the covered crops from a fall in prices below the statutorily fixed reference prices.
• But, the reference prices fixed, based on the high prices existing during the legislation debate of 2010–12, are not only much higher than the target prices fixed in the 2008 act, but also above the current market prices, warranting higher levels of deficiency payments and farm subsidy.
• This could accelerate “the move towards the US breaching its domestic support limit, set by the AoA ($19.1 billion)” (Dhar and Kishore 2016). Also, the US is more vulnerable to sharp swings in its notified support under the product-specific aggregate measure of support because of the nature of its programme and the willingness of the government to provide more support to farmers.
• A similar situation, though unintended, may frighten India’s policymakers, especially if MSPs are used as statutorily fixed reference prices, which are determined by costs of production as well as political considerations and hiked every year.
• In other words, effective implementation of price deficiency payments may be as difficult as the existing MSP policy. In fact, the risks due to price volatility and market imperfections can be often unpredictable and their management would pose a challenge.

Conclusions

• To conclude, the system of price deficiency payment is perhaps a better option than the existing system of MSPs for both the government and farmers.
• However, necessary safeguards and corrective measures have to be initiated, as and when required, to minimise the risks involved.
• Deficiency payments should be designed not only to stabilise or improve farm income but also to improve food security, fiscal prudence and sustainability of agriculture.
• From this perspective, deficiency payments should be limited or targeted to a few specific commodities unlike the PLC programme in the US which covers almost all crops and MSP in India, which covers as many as 23 crops.
• Otherwise, the relative advantages of price deficiency payment system over the MSP policy in terms of subsidy reduction would be lost.
• Besides, updation and digitisation of Aadhaar-linked land records and bank accounts along with legalisation of land leasing would be essential for any price deficiency payment programme to be adequately effective.

Note

• Calculated by the authors, using data sourced from reports of the Commission for Agricultural Costs and Prices, Government of India.