Raghav Gaiha & Vani S Kulkarni: Killing agriculture with kindness

State intervention in foodgrain marketing is motivated by two concerns: to protect producers against sharp reductions in prices, through procurement and price support operations; and to ensure access of low income households to foodgrains at affordable prices, through the public distribution system (PDS). However, a recent analysis shows that the distortions are large and glaring (R Gaiha and Vani S Kulkarni Foodgrain Surpluses, Yields and Prices in India, Global Agricultural Forum: Policy Coherence for Development, OECD, Paris, 2005). Specifically, state intervention has hampered productivity growth, regional and crop diversification, export of foodgrains, and has hurt the poor in different ways (for instance, by limiting expansion of employment opportunities and lowering of food and other entitlements).

The government of India (GoI) sets minimum support prices (MSPs) for 24 major crops, including paddy, wheat, maize, pulses and oilseeds. The Commission of Agricultural Costs and Prices (CACP) recommends MSPs for these crops every year. Farmers can sell their produce in the open market or to the Food Corporation of India (FCI) or its designated agency at the MSP.

Until recently, the GoI generally adhered to the CACP recommendation of MSPs for rice and wheat. The CACP bases its recommendations on the C2 costs of production, including all expenses in cash and in kind, plus rent paid for leased land, imputed value of family labour and interest on owned capital. Since 1997-98, the MSPs have been set higher than the C2 benchmark. In 2002-3, GoI's attempts to freeze the MSPs were resisted by the main beneficiary states (Punjab, Haryana and Andhra Pradesh). Although the MSPs were frozen at 2001-02 levels, compensations took the form of a "drought relief bonus" of Rs 200 a tonne to the paddy MSP and of Rs 100 a tonne to the wheat MSP, overlooking the fact that these crops are largely grown in irrigated areas. As a consequence, the FCI was forced to procure more, resulting in burgeoning foodgrain stocks. In 2002, for instance, the FCI had accumulated over 60 million tonnes of foodgrains "" nearly three times the normal requirements for buffer stocks and the PDS (World Bank India: Re-Energising the Agricultural Sector to Sustain Growth and Reduce Poverty, New Delhi: Oxford University Press, 2005).

While foodgrain stocks have accumulated through high MSPs, and allocations to the PDS have increased, the subsidies have risen too. Food subsidies, for example, rose from Rs 19.6 billion in 1981-2 to Rs 105 billion in 2001-2 (at 1993-94 prices). If all agricultural subsidies are added up, their total amount rose from Rs 59.2 billion in 1981-2 to Rs 364.2 billion in 1999-2000, and the corresponding share in GDP went up from 1.2 per cent to 3 per cent. That these subsidies were associated with reductions in public investment in agriculture is corroborated by a sharp decline in the latter until 2000-01 (from Rs 71.3 billion in 1981-82, to Rs 44.2 billion in 2000-01), followed by a slight upturn in 2001-02 (Rs 52.6 billion) and a negligible reduction in 2002-03 (Rs 51.5 billion) (World Bank, 2005, op. cit.).

There is growing concern that foodgrain production has slowed down as a result of slowing down of public investment in agriculture. Our findings, based on a series of econometric exercises at all-India level, are summarised below.

In the case of wheat, productivity is positively related to fertilisers used and to public investment in irrigation. However, controlling for these effects, higher gross capital formation "" implying, essentially, greater private investment in wells and tubewells "" is negatively related to yields. This may seem intriguing but if there are negative externalities of groundwater exploitation by individual farmers "" in Haryana, for instance, the average water table depth falls annually by 1-33 cm "" higher productivity on individual farms would be associated with lower productivity on other farms.

Similar results are obtained for rice yields. Both fertiliser and net sown area have positive effects on yields. The effect of public investment is positive too, while that of overall capital formation in agriculture is negative.

In the case of wheat procurement, there is a strong positive relationship with the MSP. So the higher the MSP, the greater is the wheat procurement. There is, however, a weakening of the positive effect of the MSP in recent years. The off-take of wheat is negatively related to the MSP (as the issue price rises), with a strengthening of this relationship since 1996. Stocks of wheat are positively related to the MSP, and wheat productivity. But these effects weaken in recent years.

Rice procurement is positively related to the MSP, with a slight weakening of this effect since 1996. It is also positively linked to the rice output of Haryana, Punjab and Andhra Pradesh. The off-take of rice is negatively related to both all-India rice output and to the output of these three states. Controlling for these effects, there is a negative effect of the MSP. Rice stocks vary with the MSP, but less so since 1996.

There is a positive effect of the MSPs on the wholesale food price index (WFPI). Controlling for this effect, neither the gross fiscal deficit nor the money supply (M3) has a significant effect on the WFPI. There is a residual positive time trend which weakens over time.

The Consumer Price Index for Agricultural Labourers (CPIAL) ""linked closely to rural poverty "" in turn varies with the WFPI. The former is not affected by wheat and rice off-take. Nor is it affected by money supply (M3).

Even though the share of rice and wheat in total agricultural exports grew from about 14.5 per cent in 1993-94 to about 19 per cent in 2003-04, with sharp fluctuations in the dollar value of wheat exports, it is arguable that a more rapid expansion was hampered by the sharp increases in WFPI, stemming from hikes in the MSP. Our analysis confirms this link. Exports were feasible only with subsidies, especially because international foodgrain prices crashed during the 1990s. So, a vicious circle of hikes in the MSP, leading to higher food stocks, and export subsidies to reduce them was created.

Various options have been proposed to replace the present form of the MSPs. These include freezing of the MSPs at current levels with a view to phasing them out, and using the resources saved in improving farmer access to technical advice, credit and rural infrastructure. Little, however, can be said about their feasibility except that a package of reforms with a clear and coherent rationale may have greater acceptability across India's political spectrum.

Raghav Gaiha is Visiting Professor of Economics, University of Rome "Tor Vergata", and Vani S Kulkarni is David Bell Fellow, Harvard University