Misplaced Hopes on MSP

Misplaced hopes on MSPs

V Kumaraswamy

There is some growing frustration over governments procurement of key grains under its Minimum Support Prices (MSPs) not being to lift the open market prices of those commodities and benefit the farmers. What the policy makers and economists forget is that our MSP procurement is not an end in itself but has to be studied with its end use – distribution of such procurement under our PDS programmes and how they work at cross purposes.

Effect of MSP procurement

It is generally assumed or hoped that once the MSPs are increased the open market prices would also rise in sympathy. There is insufficient realization that such procurements hardly create incremental demand. The government has limited flexibility in increasing the quantities procured under MSP which may be a surer way of enhancing prices and how increasing farm productivity from the current levels only harms the farmer interest not help them.

The effect of procurements under MSP is quite often overestimated. It is necessary to visualize the impact of procurement operations to separate reality from hope and wishes. Lets try and understand the impact through graphical exhibits. Picture 1 orders the demand from the buyers at various prices in decreasing order of prices. The thick ridge line at the top forms the demand curve as is depicted on the left side. Any procurement by government agencies at any price leads to a kink (drawing on right side) in the normal demand curve as is shown on the right picture. It shifts the demand curve horizontally in proportion to the quantity bought (dd’ in Picture 1) at the price point equal to the MSP for the crop.

 

demand supplyIn Picture 1 due to the governments initial extra demand the total demand increases but as we will see later once the government supplies the same though PDS, the effect is neutralized.

mspdsinterplay

Picture 2 studies the combined effect of demand and supply of the same commodity as in Picture 1. The normal (without intervention) demand curve DD’ is represented by the solid blue line which shifts to Ddd’d” (partially dotted line) after procurement.

The supply curve is shown as SS’ (in solid Red line). The market price without any government intervention settles at P(free).  When the Government intervenes and procures dd’ from the market at the MSP price indicated it will move the market price of independent sellers or buyers which will not be

equal to the MSP: it will settle at lower levels. Where it will settle depends upon the elasticity of the supply curve; the flatter it is, the lesser will be the price increase. In agricultural markets there are many tiny suppliers whose cost structure hardly differs from one to another since many inputs come heavily subsidized or free to most players. Hence supply curve is often flat and highly elastic. The market price will settle at P(MSP) which is way lower than MSP but higher than the free market price of P(free).

It is a fallacy to think that hiking MSPs from the current levels will result in higher open market prices. Unless the quantities procured are increased from year on year (which will keep pushing the dotted d’d” segment further and further to the right), mere yearly MSP increases will have nil or negligible impact on open market prices.  Where P(MSP) settles will depend more on the width of dd’ than where it is above the P(free) levels. (MSPs below the free market prices are useless anyway). That’s the reason why formulas like 50% over all-in cost of farmers will prove innocuous, except benefitting those fortunate to sell their crops at MSPs directly by the Government.

Given the current levels of buffer stock in FCI go-downs, any significant increase in procurement quantities will be a hazardous exercise.

Effect of PDS distribution on prices

The crops procured under MSP are used in supplying them at cheaper (than free market prices) cost through the public distribution system to end consumers. This has the effect of changing the supply curve from SS’ (without PDS operations) to Sss’s” (partially in red dotted line in Picture 2 right side). This will lower the open market price which may even settle at levels lower than the initial free market price, as is the case in Picture 2. Will the total quantities bought and sold expand as a result of these operations? It will since production will increase due to price support and so will consumption since people more people at lower levels could afford to buy more due to lower PDS prices.  The difference between procurement and PDS supplies will be accretion/depletion to buffer stocks.

Way Out

The production of agri commodities has been surplus to requirements for several years running. The buffer stocks with FCI is far more than norms and the credit to FCI from banking system at uncomfortable levels. One way would be to export the surpluses and not supply the same back in home markets through PDS. Or sell it to private sector for food processing. Alternatively, it can allow food processors and exporters to procure crops at MSPs and reimburse the difference between market price and MSPs to them. At least the handling/storage loss can be reduced. Simultaneously, the govt should reduce the size of PDS physical distribution and reimburse the consumers through Direct Benefit Transfers even if the consumers buy their requirement in open market.

A method to tweak the supply curve by partial rationalization of subsidies on inputs to increase the market prices and thus benefit the farmers was also explored in this paper (How the Agrarian Crisis can Be Eased, June 24, 2019).

It is time we realized the areas where MSPs and PDS can be effective and where they can’t be and not be fooled by misplaced faith and theories.