UPSC IAS exam preparation - Indian Agriculture and related issues - Lecture 4

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Farm subsidies and MSP mechanism in India - Part 1

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1.0 SUBSIDIES

A subsidy is a help given to someone in need, either as a direct cash payment or a reduction in some price or tax reduction. If the Indian government decides to offer fertilizers or seeds at a reduced rate to farmers, that's a classic example of subsidizing farm inputs.

It is a form of financial aid an institution, business, or sector with the aim of promoting some government policy. Subsidies are of various types, and are designed to produce a certain intended effect. Agricultural subsidies are a prominent issue in world trade. The WTO discussions usually centre around various contentious issues arising out of this.

1.1 Benefits of subsidies

The following are the benefits of subsidies

1. Inducing higher consumption/ production
2. Offsetting market imperfections including internalisation of externalities
3. Achievement of social policy objectives including redistribution of income. 

1.2 Types of subsidies in India

The estimation of subsidies is based on a standard classification relating to subsidies into three categories 

1. Public goods, 
2. Merit goods and 
3. Non-merit goods.

Subsidies result in the transfer of benefits to the individual consumer in a number of ways:

1. Cash subsidies: Providing food or fertilisers to the consumer at prices lower than those at which the government procures the commodities.
2. Interest or credit subsidies: relates to loans given at rates lower than market rates. This takes the form of concessional credit to small scale industries or priority sector loans to individuals to buy a taxi, an auto-rickshaw or to set up some small enterprise by buying some equipment.
3. Tax subsidies: can be in the form of tax exemption of medical expenses, postponing collection of tax arrears.
4. In-kind subsidies: provision of free medical services though government dispensaries, provision of equipment to physically handicapped persons.
5. Procurement subsidies: a good example is the purchase of foodgrains at an assured price which is higher than the prevailing market price.
6. Regulatory subsidies: fixation of prices of goods produced by the public sector at less than the cost with a view to providing inputs to industry or helping certain other categories of consumers. Examples are making steel, coal or other minerals available to industry, providing electricity to farmers at a rate much lower than the cost.

There is a consensus on the provision and continuance of subsidies on merit goods since the overall benefit to the society in the form of externalities is much larger. However, the provision of subsidies on non-merit goods has come in for sharp criticism since in their case, the benefits accrue to the individual while the costs are borne by the society. Moreover, in several cases, instead of the intended beneficiaries, the benefits are appropriated by better-off sections. For instance, it is alleged that benefits of the provision of cheap electric energy to farmers are, by and large, appropriated by rich and affluent farmers. Similarly, better off sections may take advantage of a generalised scheme of public distribution of foodgrains or other essential commodities.

There are two major types of subsidies, which are the fertiliser and the food subsidy. They account for more than 80 percent of agricultural subsidy. In addition to this, the agricultural income is not taxed in India. The issue nowadays revolves around fertiliser subsidies. Here’s some data:

2. 0 MINIMUM SUPPORT PRICES

A recent research by NITI Aayog points out that Indian agriculture is confronted with several issues. The five major issues identified were : (1) agricultural productivity, (2) remunerative prices for farmers, (3) land policy, (4) agrarian distress and (5) eastern states that have lagged behind the rest of the country in farming. 

First, a series of essential steps are required to raise agricultural productivity. To increase productivity, progress is required in (i) Quality and judicious use of inputs such as water, seeds, fertilizer and pesticides; (ii) judicious and safe exploitation of modern technology including genetically modified (GM) seeds; and (iii) shift into high value commodities such as fruits, vegetables, flowers, fisheries, animal husbandry and poultry. 

The second issue is related with farmers' need to receive remunerative prices. This issue has two aspects, one relating to the Minimum Support Price (MSP) and the other relating to the farmer's share in the price paid by the final consumer. 

2.1 Understanding MSP

India inherited an agrarian economy from the British with the agriculture and allied sector contributing to around 75% of the Gross Domestic Product (GDP) and providing employment to more than 80% of the population. The food shortages faced during the mid-1960s pushed India to reform its agricultural policy and accordingly India adopted significant policy reforms focused on the goal of achieving foodgrain self-sufficiency. 

A series of institutional reforms was undertaken to boost the agricultural production and to modernize the farming practices. These included land reforms, structural changes in the agricultural administrative arrangements, agricultural extension schemes, initiation of price support policies including the introduction of the Minimum Support Price (MSP) for major agricultural produces, introduction of new technologies (popularly known as the green revolution), strengthening of agricultural research, etc. The agriculture and allied sectors grew at an average rate of 3.6 per cent a year during the 11th Five Year Plan (2007-12). 

Given the limitations in the expansion of acreage, the main source of longterm output growth has been the improvement in yields. A comparative picture in the average annual growth rates of area, production and yield of different crops for the last two plan periods, i.e. the 10th Plan (2002-03 to 2006-07) and the 11th Plan (2007-08 to 2011-12) are given in the Image. It gives a macro view of Indian agriculture.

2.2 Determination of Minimum Support Price

The prices of agricultural commodities are inherently unstable, primarily due to three reasons (1) the variation in their supply, (2) lack of market integration and (3) information asymmetry. 

A very good harvest in any year results in a sharp fall in the price of that commodity during that year which in turn will have an adverse impact on the future supply as farmers withdraw from sowing that crop in the next / following years. This then causes paucity of supply next year and hence, major price increase for consumers.

The logic is - 

Excellent output of X Þ Price falls Þ Farmers demotivated Þ Stop growing X Þ Supply of X drops Þ Price shoots up Þ Consumer panic in market

To counter this, MSP for major agricultural products is fixed by the Government, each year. MSP is a tool which gives guarantee to the farmers, prior to the sowing season, that a fair amount of price is fixed to their upcoming crop to encourage higher investment and production of agricultural commodities. The MSP is in the nature of an assured market at a minimum guaranteed price offered by the Government. 

2.3 Who fixes the MSP?

The MSP is fixed on the recommendations of the Commission for Agricultural Costs and Prices (CACP). The CACP is a statutory body and submits separate reports recommending prices for Kharif and Rabi seasons. The Central Government after considering the report and views of the State Governments and also keeping in view the overall demand and supply situation in the country, takes the final decision. In case of sugarcane, MSP has been assigned a statutory status and as such the announced price is termed as statutory minimum price, rechristened as Fair Remunerative Price (FRP). There is statutory binding on sugar factories to pay the minimum announced price and all those transactions or purchase at prices lower than this are considered illegal. MSP for the different agricultural crops viz., food grains, oil seeds, fibre crops, sugarcane and tobacco are announced by the Government of India before their sowing seasons. This makes it possible for the farmer to have an idea about the extent of price insurance cover provided by the government for the crop. 

A detailed yearwise comparison of what the CACP recommended and what the government finally fixed, is given in the table at the end of this lecture. Do refer that to get an idea of how the process works.

2.4 How many crops are covered?

Initially, MSP covered paddy, rice, wheat, jowar, bajra, maize, ragi, barley, gram, tur, moong, urad, sugarcane, groundnut, soybean, sunflower seed, rapeseed and mustard, cotton, jute and tobacco. From 1994-95 onwards, Nigerseed and Sesame were included under MSP Scheme of CACP, in addition to the edible oilseeds already covered by the Commission. Similarly, during 2001-2002, the government enhanced the terms of reference of the Commission by including lentil (masur). The number of crops covered by MSP scheme has now increased to 25 (26). 

2.5 What are the present MSP rates?

Given is the list of MSP rates, present as well as historical. Do read the index at the bottom of the table.

2.6 How viable is the MSP mechanism?

The government has to study the factors involving a large number of crops, currently 24, grown in different agroclimatic zones, with multiple and varied organisations involved in their implementation.

Understandably, for one crop there may be a certain set of issues plaguing its effective implementation, which may be completely at variance with issues concerning other crops. In other words, every MSP commodity will have its own special characteristics and consequently different farmers growing different commodities in different regions of the country will have different perceptions about the usefulness, or otherwise, of the MSP scheme. It is quite a cumbersome exercise to document the multifarious and complex issues involved in the MSP Study. 

When the Niti Aayog presented a report in 2016, it said that the objectives of the evaluation study were the following:

1. To explore and analyze the effectiveness of price policy in India in the context of nationwide price support objectives set forth by the government. 
2. Impact of MSP on creating a predictable and equitable crop price regime.
3. To identify regional and inter-crop variations in the implementation of MSP and reasons for the same.
4. To study and evaluate the impact of MSP on cropping patterns
5. To evaluate impact of MSP on long term agricultural competitiveness.
6. To evaluate impact of MSP on optimal land and water use and sustainability on a nationwide basis.
7. To evaluate whether adoption of improved technology, appropriate investment and rural infrastructure has been aided by MSP.
8. To suggest measures for creating more effective MSP.

Also, the following table shows the overall weight of some important crops.

2.7 Recommendations regarding MSP

Following are some important recommendations regarding the way forward.

1. The awareness among the farmers needs to be increased and the information should be timely disseminated till the lowest level so that the knowledge would increase the bargaining power of the farmers.
2. Delays in MSP payments have negative effects on the farmers which needs to be corrected and timely payment should be ensured.
3. As intended by the policy makers, MSP should be announced well in advance of the sowing season so as to enable the farmers to plan their cropping.
4. Improved facilities at procurement centres, such as drying yards, weighing bridges, toilets, etc. should be provided to the farmers. More godowns should be set up and maintained properly for better storage and reduction of wastage.
5. There should be meaningful consultations with the State Government, both on the methodology of computation of MSP as well as on the implementation mechanism.
6. The criteria for fixing MSP should be current year's data and based on more meaningful criteria rather than the historical costs.

3.0 Fertilizer subsidies: Issues and problems

In 1967, then-Prime Minister Indira Gandhi imported 18,000 tons of hybrid wheat seeds from Mexico. The effect was miraculous. The wheat harvest that year was so bountiful that grain overflowed storage facilities.

Those seeds required chemical fertilizers to maximize yield. The challenge was to make fertilizers affordable to farmers who lacked the cash to pay for even the basics-food, clothing and shelter. Back then, giving cash or vouchers to millions of farmers living all over India seemed like an impossible task fraught with the potential for corruption, as there was no technology like internet or mobile available. So the government paid subsidies to fertilizer companies, who agreed to sell for less than the cost of production, at prices set by the government. This is the basic concept of fertiliser subsidy.

Fertilizer manufacturing companies sprang up around the country. Nagarjuna Fertilizers & Chemicals Ltd. became one of the most profitable publicly listed companies in India.

Today India is one of the largest producer and consumer of fertilisers. The current level production of fertiliser is 16.5 million tonnes. Consumption is 26 million tonnes.

Fertilzers subsidies were started in India in 1977. The scheme then was retention price cum subsidy scheme (RPS) where retention price is fixed price paid to company. Later in 2003 Manmohan Singh changed it to new pricing scheme (NPS).

The main features of the system of fertilizers subsidies in India are:

1. The issue is that how much of it is going in the pocket of farmer and how much to fertiliser companies. A research conducted by IIM Ahmedabad says that on an average 67 percent of subsidy is going to the farmer. The remaining mainly goes to fertilizer companies.  
2. Another issue is that how much is going to small, needy farmers and how much to the large farmers. The same research says that 52 percent of subsidy goes to small farmers.
3. How much of subsidy is going to well developed regions and how much to less developed regions is another question.  More than 50 percent of subsidy is going to only 5 states. 
4. The subsidies are mainly used for fertilizers concentrated on crops like rice, wheat, cotton and sugarcane.

In 1991, with the cost of the subsidy weighing heavily on India's finances, Manmohan Singh (then finance minister) pushed to eliminate it. Most fertilizer companies lobbied fiercely to retain the programme. Many legislators also resisted ending the subsidy, fearing a backlash from farmers. The government then subsidized other fertilizers besides urea. In budget crunches, subsidies on those fertilizers have been reduced or cut, but urea's subsidy has survived. That's because urea manufacturers form a powerful lobby, and farmers are most heavily reliant on this fertilizer, making it a political hot potato to raise the price. 

"That's when the imbalanced use of fertilizers began," says Pratap Narayan, ex-director general of the industry group, the Fertilizer Association of India. "The business interests lobbied and the business interests prevailed," says Ashok Gulati, the director in Asia of the International Food Policy Research Institute, a Washington-based think tank, who was involved in the policy discussions at the time. A last-minute compromise eliminated the subsidy on all fertilizers except for urea. Over-production and over-use of fertilisers lead to environmental degradation. In the state of Haryana, farmers used 32 times more nitrogen than potassium in the fiscal year ended March 2009, much more than the recommended 4-to-1 ratio, according to the Indian Journal of Fertilizers, a trade publication. In Punjab state, they used 24 times more nitrogen than potassium, the figures show.

"This type of ratio is a disaster," Mr. Gulati says. "It is keeping India from reaching the production levels that the hybrid seeds have the power to yield."

This is a vicious circle. The soil is getting weaker and weaker over the last 10 to 15 years. We need more and more urea to get the same yield. The overuse of one type urea is so degrading the soil that yields on some crops are falling and import levels are raising. So are food prices, which jumped 19% last year. The country now produces less rice per hectare than its far poorer neighbours: Pakistan, Sri Lanka and Bangladesh. China has 6.5 tonnes per hectare, Pakistan 3.5, India 3.4.

The excess fertilizers make their way into the food chain, causing harm to human beings, animals, birds, and insects and disturb the soil's ecological balance. Excess use of fertilizers can also pollute ground water and other water sources. All of this can cause a health hazard to impacted populations of plant, animal and human beings. Human beings who consume food that has been grown through use of excess fertilizers carry the risk of contracting various diseases.

4.0 Agricultural subsidies and the WTO

Farm subsidy is an issue that has divided the membership of the multilateral trade body ever since it was created. The heavy amounts of subsidies given by the developed countries to their farmers have been distorting international trade to the detriment of the interests of the developed countries.

Under the WTO's Agreement on Agriculture, member countries are required to reduce and gradually end all agricultural subsidies.

The WTO recognises three kinds of agriculture subsidies.

"Amber box" measures are those that distort trade most severely. Developing countries are allowed to provide such subsidies worth up to only 10% of the total value of their agricultural production; developed countries are allowed up to 5%.

The second category of subsidies, the "blue box", are considered slightly less distorting; developing countries are subject to an 8% ceiling on their blue box support.

And finally, "green box" subsidies are those that are not thought to distort trade at all; these are not subject to any conditions or limitations. Examples of green box subsidies include direct income support to farmers as well as policies for environmental protection and regional development. Most developed countries have shifted towards green box subsidies for agriculture, so they continue to provide enormous support to their farmers without breaching WTO commitments.

India's recent Food Security Law that seeks to provide food security to one of the largest undernourished populations in the world was challenged by the US in the WTO, even though India's scheme would cost a fraction of what the US provides in food subsidies. Finally, the WTO relented and gave India the indefinite peace clause, in the Bali trade round, December 2013.

This is because of archaic rules that allow higher levels of subsidies and protection for rich countries compared with developing ones. India had insisted on a permanent exemption from the WTO rules but failed to get it. The final text recommended working out a permanent solution within four years. This almost brought the entire WTO Doha Round (Bali round) to near-collapse but a last-moment understanding between US-India in 2014 saved it, and paved the way for the first WTO - Trade Facilitation Agreement 2015.

4.1 The global problem with farm subsidies

The biggest problem in agricultural subsidy is that you cannot distinguish between the needy and a non-needy. In the US, 90 percent of subsidy goes to the largest 25 percent of farms. In European Union, Japan and Canada this figure is 70 percent. Controversy about the real benefits of subsidies is a world phenomenon.

Joseph Stiglitz, a Nobel laureate in economics, has argued that reduction of farm subsidies have a long term effect of raising global food prices, which in fact harms the poor, increases malnutrition, etc. And the economic explanation of so is that it alters free market conditions.

Also subsidies hamper terms of trade, and so don't allow a nation to take benefits of comparative advantage.

Another issue is the inefficiencies created by subsidies. Subsidies in areas such as  education, health and environment merit justification on grounds that their benefits are spread well beyond the immediate recipients, and are shared by the population at large, present and future. For many other subsidies, however, the case is not so clear-cut. Arising due to extensive governmental participation in a variety of economic activities, there are many subsidies that shelter inefficiencies or are of doubtful distributional credentials. This is so especially in India where administrative management doesn't have a complete control on corruption.

 

There are issues like the straining effects of agricultural subsidies on the sub-optimal use of scarce inputs like water and power induced by subsidies, and whether subsidies lead to systemic inefficiencies. Inadequate targeting of subsidies is also a big debate.

 

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