MSP: Why subsidy to farmers be replaced with incentives

One of the key concerns for the market has been the annual rise in the minimum support prices (MSP) given by the government and recommended by the Agricultural Price Commission. This year a increases from 20% and 50% depending on the crop was witnessed.

The MSP for paddy inched close to 20% and core serials prices also got a bigger push. This will have an impact on the CPI (Consumer Price Index) and subsidies in the days ahead.

In an interview to CNBC-TV18 Ashok Gulati, chairman of Committee for Agricultural Costs & Prices explained the process of fixing MSP and its impact on inflation. 

Below is the edited transcript of Gulati’s interview with CNBC-TV18. Also watch the accompanying videos.

Q: We see this as an annual feature. Almost every year we see a 20% rise in the major crops and in certain cereals much more. What is the basis for this increase?

A: There are four-five factors that go into fixing or recommending those minimum support prices. One very critical element in the game is the cost of production. There are many factors behind that - labour cost for example in the last three years has gone up by 74% from the farmers, the fertilizer prices have gone up, the diesel prices have gone up.

When these costs are increasing then you need to incentivise a farmer by keeping at least some of its cost in control and giving him reasonable prices, otherwise the margins will turn into negative. That was the story for most of the minimum support prices (MSP) that on MSP, the costs were higher and they were having in fact negative rates of return on many commodities.

So it was an attempt to reposition. Now, cost is not the only element which goes into the pricing of these products. We do take care of the demand and supply situation and what is happening in the international markets. We look into that what other countries in the neighbouring region or Asian countries are paying to their farmers. So, all these factors are taken into account while recommending the prices to the government.

Q: You mentioned labour costs as one of the cause. Diesel and other costs are beyond our reach although administered price of diesel in India have been controlled. Labour costs to some extent are created by the MSP itself. This is a constant argument that comes from the Reserve Bank and the economists that because the MSP is high it leads to an increase in CPI and because the CPI is high it increased to higher payments in the NREGS (National Rural Employment Guarantee Scheme) and other state supported payments and that once again becomes a higher cost. As an agricultural economist rather than just the head of the commission how does one break this circular jinx?

A: No, I am not very much convinced that MSP is the only determinant of the labour cost. The labour cost depends upon what is happening to the demand and supply of labour in the economy. If construction is booming in the economy let us say and people are getting into construction activities and if government intervenes in the labour market through NREGA (National Rural Employment Guarantee Act) type of activities, all these factors ultimately determine what the wage rate in the country is.

MSP maybe a very miniscule part of the game and saying that MSP is fueling the labour costs in the system -- actually it’s the other way round. I would say that the hike in the labour costs is compelling the farmers to look for ways and means how to protect their margins. So one question that you may put is how to control these labour costs.

Q: How much of an incentive is the hike in MSP prices for farmers in order to produce more and the other possible variable that we are working with in this season is a monsoon, which hasn’t picked up as yet. According to you what sort of margins are farmers working with, with regards to the higher MSP prices which have been undertaken? What would your probability be in higher production this time around?

A: Even in a case like paddy our estimates are that the projected cost for the coming season for the paddy producer weighted average for the country as a whole is Rs 1,185 per quintal. We are giving only 5.5% margin on the weighted average. It will still not cover the farmer’s cost in some of the most dominating paddy producing states like West Bengal.

If we call that as a very high price then there is something serious in this country. The producers who are producing and taking all the risk of monsoon and the risk of the market if they are given only 5.5% return on their investments what incentives are we talking for agriculture.

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Q: Is there any way in which productivity incentives are provided at all in the MSP or that’s not a point that you take into consideration?

A: Sure. At the end of the round if you want to control costs the solution lies in augmenting productivity and augmenting productivity needs investments. Today more than 3/4th of the investment that is going to agriculture is coming from the farmers. Only 1/4th comes from the government side. Farmers, unless they get incentives they are not going to invest in agriculture and therefore productivity will not go up.

Unfortunately, the government resources going into agriculture, they are not less, they are sufficient, but 80% of those resources are going through subsidies. The marginal returns on those subsidies are much less than investments through public resources. So, government has to really shift the gears. Rather than giving subsidies into the agriculture they must be investing particularly in water, augmenting irrigation and agriculture R&D, that’s the only way to go forward.

Q: So basically you are asking for a replacement of fertilizer subsidy because the other two don’t go to agriculture I guess - food and diesel?

A: I would be very much open in that and say that it is high time to rationalize the fertilizer subsidy. You have almost Rs 75,000 crore into that kitty and NPK ratio. The optimal should be 4:2:1. In Punjab and Haryana it is 20:9:1.

We need to rationalize that. It is high time to how can we best rationalize and prune these subsidies but simultaneously go for more investments in agriculture - that’s the right way.

Q: In specific with regards to the hike in MSP prices which are undertaken this time around, according to you what would be the impact on food inflation, hence what sort of levels could we see possibly in food inflation which is already above 10%?

A: There is lot of concern on food inflation. I appreciate those concerns that have been raised in the media and by many scholars. You look at the structure of food inflation today. The highest pressure is coming from vegetables. Vegetables are not under MSP regime at all. The second biggest pressure on food inflation is coming from protein food - milk, meat, fish and eggs they are also not under MSP.

We have to understand that it is not the cereals which are pushing food inflation up. It is the demand of those high value commodities where the supply lines are very weak. We are not connecting the farmers with processors and organized retailers. If we don’t go in a big way to do that then you are going to have fragment in supply lines and high rates of inflation and that is what is happening right now.

Q: What is your own estimate of the monsoon? Do you think that the shortfall that we have been seeing can be damaging and therefore would you want to forecast agri output in the current year?

A: It’s too early to speculate that, but we have to monitor. Only two-three days back I was in a village in remote corners of India and the entire potato crop is lost because for the last one month not a drop of rain was there. Farmers have totally lost their crop.

So it is not yet a panic situation at pan India level for the major crops, but it is a case of very close monitoring on a day-to-day basis.

I am worried about in the second half of monsoon because if El Nino comes then we may have a damaging crop. Only good thing at present in this bleak outlook is that we have ample stocks of wheat and rice, so we can easily withstand that type of a shock, if at all it comes.