Agriculture: Issues Related to Minimum Support Prices

(MSP), WTO and Subsidies

insightsonindia.com/2014/11/14/agriculture-issues-related-minimum-support-prices-msp-wto-subsidies/

November 14,
2014

Pricing policy and WTO

1. Minimum Support Price

2. Additional bonus announced by Center and States
3. Commission for Agriculture Cost and Prices (CACP)
4. Criticism of MSP
5. MSP on Minor forest produce (MFP)
6. Levy procurement System
7. WTO and Subsidies

India is faced with a complicated situation as on one hand there is record production of
cereals and on the other hand there have been trends of stagnant high inflation even when
FCI godowns are overstocked. Many blame India’s minimum selling price policy for this
situation. It has two unintended negative impacts; one is growth in agriculture is not
dictated by demand of economy, other is persistent inflation. There are many other
1/13
interventions which are isolated/unintegrated and lack broad vision of sector as a whole.
Further, India has challenge to align domestic markets with international markets as exports
of agriculture products can bring more prosperity to country side. It is said that 1% increase
in Agro exports results in Inflow of 8500 crores in the sector. In this sense we can’t ignore
WTO negotiations. These are to be negotiated while taking care of sovereignty and food
security of India.

1. Minimum Support Price

MSP initially was started as a safety net for farmers through a guarantee that if there
produce is left unsold in the market, will be bought by the government. Another purpose
was to incentivize farmer to produce more crops so as to ensure food security in India.

An ideal environment for this is one in which market prices are higher than support prices.
When new crop comes to the market it will be sold at market prices and a situation was
possible where on fulfillment of needs of consumers and industry, surplus is left with
farmers. This will happen when production is more than demand. Such situation will result
in crash of prices of agri products. It is this time when government should ideally intervene
and purchase unsold stocks.

This policy took off in 1960’s and at that time Procurement prices were announced at
beginning of sowing season, along with MSP. Procurement price was one under which
government will buy the crop which it needs to maintain buffer stock or for PDS. Once
quantity required has been purchased, farmers could only sell at MSP, which were kept
lower than Procurement Prices. Procurement prices were always kept lower than Market
Prices. So preference of farmer was to sell in this manner – 1st: Market, 2nd: Government at
Procurement Price, 3rd: Government at MSP.

From very beginning these prices were skewed in favour of food grains mainly Rice and
Wheat. Soon growth rate of production of these food grains outpaced Growth Rate of
population and demand. This was time when government should have changed its policy to
diversify Farm basket more toward, protein rich crops or horticulture, but this didn’t happen
and patronage to Cereals continued. In 1990’s government started announcing only MSP
which was also procurement price. This was so because by this time MSP was a big political
plank and majority of farmer community was comfortable with Rice and Wheat due to their
comparative high yields. If MSP was greater or equal to procurement prices or market
prices, there is obviously no need of procurement prices. Since then MSPs has seen
constant upswings.

1. Additional bonus announced by Center and States

2/13
Apart from MSP, center often announces additional bonuses on the crops. Over the MSP
and bonus of Central Government, states also declare additional bonus. Problems are same
but become aggravated. Recently government took step in this regard by – limiting
procurement from states that declare additional bonus, to the level of requirement of PDS
and other schemes. Not all quantity offered will be brought now.

1. Commission for Agriculture Cost and Prices (CACP)

Originally created as Agricultural Price Commission in 1960’s to recommend Minimum

Selling prices for 11 crops and later it was renamed as CACP. It was a move to provide
minimum floor price for these crops. It was felt that a government buying agency is
prerequisite for effective implementation of MSP and Food Corporation of India was also
created for procurement of foodgrains. Later for procurement of pulses and oilseeds,
‘National Agricultural Cooperative Marketing Federation of India Ltd’ (NAFED) created. So
prices are recommended by CACP for all products, foodgrains are procured by FCI and
pulse and oilseeds are procured by NAFED. However, horticulture, vegetables, fruits or dairy
products have no such support.

As of now MSP is recommended for 24 crops under 5 groups viz. Kharif Crops, Ragi crops,
Sugarcane, raw jute and copra.

For sugarcane instead of MSP, ‘fair and remunerative price’ is declared. It depends upon
recovery percentage which varies from state to state. For other crops one MSP is declared
for whole India. In beginning practice was to declare regional prices. This was so because
Input costs and returns of crops vary from region to region. But later uniform MSP system
was restored on ground that it alone could lead to comparatively efficient use of resources
in line with their comparative advantage.

Other issue is of data on which commission relies. In this case ‘Directorate of Economics
and statics’ gives inputs about cost of cultivation to CACP. This data is assimilated over a
long period and there is time lag of about 2 years. So MSP fixed this year will be based on
data captured 2 years back. This at times has given significant variations in computation of
MSP. To remedy this CACP use an adjustment factor taking into account Inflation, but this is
not effective.

MSP is based on economic criteria such as demand and supply situation, trends in domestic
and international market prices, cost of production, inter-crop price parity, terms of trade
between agriculture and non-agriculture sectors, trade policy in agriculture, effect on
general price level, and so on.

It should be noted that ‘cost of production’ is just one of the factors taken into account and
is not a sole factor. Few years back Swaminathan Committee recommended that MSP
should be cost plus 50% mark up, but this was not implemented. Other Important factors

3/13
which is considered is ‘demand in the economy’ this was added to terms of reference in
2009. As discussed in the beginning non sync of MSPs with demands of economy was
realized and this step was taken.

However, methodology of CACP doesn’t have any specific weights attached to various given
factors and MSP is influenced by Subjective discretion of members. CAG also criticized
methodology on grounds of non-transparency.

Note that Jowar, which is a coarse grain, has its MSP higher than Rice. Cultivated area under
Jowar was on persistent decline and to arrest this decline its MSP was raised substantially in
2011.

4/13
MSP regime is often criticized on ground of –

Distorted Production

Recent trends by NSSO indicates shift in pattern of food consumption from cereals to
protein rich foods, but no such remarkable shift is seen in sowing or production patterns.
For e.g. India is largest producer and consumer of pulses in the world, but still 25 % of the
pulses consumed are imported.

Huge Stocks

This resulted in ‘Open ended procurement’ which means government can’t decide quantity it
wants to buy. How much ever grains are offered by farmers to gov. has to purchase. So now
government has huge stocks which are almost double the requirements for Buffer stock,
PDS and Other government schemes such as Midday Meal Scheme.

Out of control Inflation

As we have seen initially MSP and procurement prices were kept lower in relation to Market
Prices. So lower the market prices, even lower were MSP and procurement prices. Situation
now is that Market prices are dictated by MSP which remains most of the time higher. This
brings market prices atleast on par with MSP. Data suggests an obvious directly
proportional link between hike in MSPs and Food Inflation.

Only 1/3rd of the total cereal production is left for open market after government
procurement and captive consumption by the farmers. This creates shortage in open
market and abundance in government godowns.

Also, inflation in crops not covered under MSP is because of other reasons. As we have seen
there is shift in consumption pattern toward non cereal foods, but no corresponding growth
in production. As a result there is demand supply mismatch. So growth in non-cereal
production is compromised in favour of crops that fetch higher yields, which is out of sync
with market demand.

Backwardness in Agriculture

5/13
Any industry grows when it adapts to a competitive environment. If farmers get market
signals from the market about upcoming trends of demands of consumers, total supply in
economy, new technologies, export opportunities or import vulnerabilities, they will find out
more profitable crops, technologies and will keenly adapt. Present system creates glut in
market of particular crops. It leads to intensive farming year after year, which degrades soil.
Farmers rely on political pressure to remedy their problems, instead of adapting to market.
This all keeps private investment away for the sector.

Notwithstanding all this, it is unquestionable that our farmer needs support. Question
under debate is what sort of support should farmer get? Currently farmers besides
numerous other input subsidies are getting crop specific support. This means that our
policy makers dictate agricultural product mix, which otherwise is domain of consumers. For
this it is essential that –

1. Support should be Crop Neutral as has been recommended by many experts on the
topic. If all farmers get same monetary support despite of crops produced, then they
are better placed to diversify their crops as per demands of the market. This can be
done by changeover to Income support from MSP.
2. Farmers should get support at the time of distressed market prices. 1 st preference of
farmers should be to sell in market. At price which should be higher than MSP

MSP on Minor forest produce (MFP)

The MFP gatherers are mostly poor who are unable to bargain for fair prices. Govt. of India
has decided to introduce the scheme of “Mechanism for Marketing of Minor Forest Produce
(MFP) through Minimum Support Price (MSP) and development of value chain”. The scheme
is designed as a social safety net for improvement of livelihood of MFP gatherers by
providing them fair price for the MFPs they collect.

The scheme has been started with following objectives

To provide fair price to the MFP gatherers for the produce collected by them and
enhance their income level
To ensure sustainable harvesting of MFPs.
The Scheme will have a huge social dividend for MFP gatherers, majority of whom are
tribals.
It is a holistic scheme for development of MFP trade including its value chain and
necessary infrastructure at local level. The MSP scheme seeks to establish a
framework to ensure fair returns for the produce collected by tribals, assurance of
buying at a particular price, primary processing, storage, transportation etc while
ensuring sustainability of the resource base

Levy procurement System

6/13
State Governments/UT Administrations issue levy orders in exercise of the powers
delegated to them under the Essential Commodity Act, 1955 after obtaining the prior
concurrence of Central Government.

The aim is to increase procurement for government’s buffer stocking and distribution
through PDS. Rice millers are mandated to supply a certain proportion (levy) of
processed rice to the FCI at a fixed processing margin.

The percentage of rice is fixed by the state governments taking into account
requirements of the Central Pool, domestic consumption and marketable surplus. The
centre fixes the prices of levy rice, which are typically below the market price, before
the Kharif Marketing Season (KMS) commences. The quantum of levy varies across
states and ranges between 30 per cent and 75 per cent.

In nineteen of the 23 states/Union Territories that impose the levy it is 50 percent or

more; it is 60 per cent in Uttar Pradesh and 75 per cent in AP, Haryana, Punjab,
Uttrakhand and Odisha thus leaving little rice for the open market. Kerala is the only
state that has no system of levy.

The adverse effects that rice levies have on the markets are obvious: they discourage
rice millers’ investment, increase private traders’ transactions costs, breed corruption,
and create rents for special interests. Since millers are not allowed to sell in the open
market until levy requirement is met and because market price is generally higher
than levy price, it creates various avenues of corruption in the foodgrains marketing
chain. Further bad quality is supplied to government (such as broken rice) which
otherwise would have fetched low prices.

Until last year sugar was also under levy and non-levy obligations, on
recommendations of Rangarajan committee these were removed. Under Non levy
obligations Sugar mills were given fortnightly, monthly, half yearly quotas for sale of
sugar. This was because sugarcane is seasonal crop and about 90% of sugar is
produced in just two months. Unregulated sale can create avenues for hoarding and
big price fluctuations.

WTO and Subsidies

WTO’s agreement on agriculture was concluded in 1994, and was aimed to remove
trade barriers and to promote transparent market access and integration of global
markets. Agreement is highly complicated and controversial; it is often criticized as a
tool in hands of developed countries to exploit weak countries. Negotiations are still
going on for some of its aspects.

Agreement on agriculture stands on 3 pillars viz. Domestic Support, Market Access,

and Export Subsidies.
7/13
1. Domestic Support – It refers to subsidies such Guaranteed Minimum Price or Input
subsidies which direct and product specific. Under this Subsidies are categorized into
3 boxes –
1. Green Box – Subsidies which are no or least market distorting includes
measures decoupled from output such as income-support payments (decoupled
income support), safety – net programs, payments under environmental
programs, and agricultural research and-development subsidies.
Such as Income Support which is not product specific. Like in India farmer is
supported for specific products and separate support prices are there for rice,
wheat etc. On the other hand income support is uniformly available to farmers
and crop doesn’t matter.

US has exploited this opportunity to fullest by decoupling subsidies from

outputs and as of now green box subsidies are about 90% of its total subsidies.
It was easy for USA because it doesn’t have concern for food security. Further, it
has prosperous agro economy, and farmers can better respond to markets and
shift to other crops. But in India, domestic support regime provides livelihood
guarantee to farmers and also ensures food security and sufficiency. For this
MSP regime tries to promote production of particular crop in demand. And this
makes decoupling Support with output very complicated.

USA was also in position to subsidies R&D expenditure in agriculture as almost

all the farming in US is capitalist and commercial. Big agriculturists spend
substantial amount on technology upgradations and R&D. But in India about
80% of farming is subsistence and hence, India & other developing countries can
use this opportunity.

2. Blue Box
– Only ‘Production limiting Subsidies’ under this are allowed. They cover
payments based on acreage, yield, or number of livestock in a base year.
‘Targets price’ are allowed to be fixed by government and if ‘market prices’ are lower
than farmer will be compensated with difference between target prices and market
prices in cash. This cash shall not be invested by farmer in expansion of production.

Loophole here is that there no limit on target prices that can be set and those are
often set far above market prices deliberately. USA currently isn’t using this method,
instead here EU is active.

1. Amber Box
– Those subsidies which are trade distorting and need to be curbed.
The Amber Box contains category of domestic support that is scheduled for reduction
based on a formula called the “Aggregate Measure of Support” (AMS).

8/13
The AMS is the amount of money spent by governments on agricultural production,
except for those contained in the Blue Box, Green Box and ‘de minimis’.

It required member countries to report their total AMS for the period between 1986
and 1988, bind it, and reduce it according to an agreed – upon schedule. Developed
countries agreed to reduce these figures by 20% over six years starting in 1995.
Developing countries agreed to make 13% cuts over 10 years. Least – developed
countries do not need to make any cuts.

As we can note that Subsidies were bind to levels of 1986-1988, there was inequality at
very beginning of the agreement. At that time subsidies which latter came under
‘Amber Box’ were historically high in western countries. In developing countries,
including India these subsidies were very limited. It is only now under pressure of
Inflation in prices of agricultural Inputs, and wide differences between market prices
and Minimum support Price, subsidies have grown to this level. In effect developed
countries are allowed to maintain substantially higher amount of trade distorting
subsidies.

De-Minimis provision

Under this provision developed countries are allowed to maintain trade distorting
subsidies or ‘Amber box’ subsidies to level of 5% of total value of agricultural output.
For developing countries this figure was 10%.

So far India’s subsidies are below this limit, but it is growing consistently. This is
because MSP are always revised upward whereas Market Prices have fluctuating
trends. In recent times when crash in international market prices of many crops is
seen, government doesn’t have much option to reduce MSP drastically. By this analogy
India’s amber box subsidies are likely to cross 10% level allowed by de Minimis
provision.

Bali Summit, Trade facilitation and Peace Clause

These provisions are not agreed to by India yet and for this Negotiations are going on.
This matter was taken up in recent Bali meet and an interim peace clause was reached
at. Developed countries made an attempt to couple negotiations on this issue with
another issue of ‘Trade facilitation’. Under a package, ‘Trade facilitation’ was agreed to
by all nations and for revision of limits under de minimis provisions; a ‘Peace clause’
was agreed at. Please clause gave countries 4 year times to adjust to the limit and
avoid sanctions.

Date for ratification of Bali agreement was 31 July, 2014, on which India declined to
ratify unless a ‘permanent solution’ is reached. After this in November, India – US
reached understanding in which time limit of 4 years was removed and in return Trade
9/13
Facilitation was agreed to by India.

Notably in Deal at Bali, Developed countries were able to woo under developed
countries on basis of a ‘Special Package’ for them directed toward Social and physical
infrastructure. India as a result was isolated in all this, only South Africa extended
some support to India’s stand

Trade Facilitation requires member countries to invest in Infrastructure that facilitates

Imports and exports, simplify custom procedures and remove other non-tariff
barriers.

It should be note that development of Infrastructure is already a priority for

government and it is much desirable in agriculture too, as India is net exporter of agri
products. But issue was of 4 years of ‘peace clause’, which now stands removed.

‘Trade facilitation deal’

was marketed by developed countries as a progressive and much needed deal for
good of all type of countries. It is being said that it will boost up Global GDP by $ 1
Trillion and will add millions of new job. This argument has a little or no empirical
backing and it is feared that western supplier will invade domestic markets of
developing and underdeveloped countries. ‘Trade facilitation’ along with ‘special
package’ is like saying that gains of developed countries will be so big, that losses of
under-developed countries will be lucratively compensated by them.

10/13
11/13
Market Access: The market access requires that tariffs fixed (like custom duties) by
individual countries be cut progressively to allow free trade. It also required countries
to remove non-tariff barriers and convert them to Tariff duties.

Earlier there were quotas for Imports under which only certain quantities of particular
commodities were allowed to Import. This is an example of Non-tariff Barrier.

India has agreed to this agreement and substantially reduced tariffs. Only goods
which are exempted by the agreement are kept under control.

Maximum tariff has been bonded as required by WTO, under which a higher side of
tariffs is fixed in percentage that should never be surpassed. Generally actual tariffs
are far below this high limit. This makes custom policy transparent and tariffs can’t be
fixed arbitrarily.

12/13
 If India is able to diversify its production and add value by food processing, then this is
a win-win deal for India. A number of commodities are exported to West and low
tariffs in west will benefit Indian suppliers.

Export Subsidy: These can be in form of subsidy on inputs of agriculture, making

export cheaper or can be other incentives for exports such as import duty remission
etc. These can result in dumping of highly subsidized (and cheap) products in other
country. This can damage domestic agriculture sector of other country.

These subsidies are also aligned to 1986-1990 levels, when export subsidies by
developed countries was substantially higher and Developing countries almost had no
export subsidies that time.

But USA is dodging this provision by its Export credit guarantee program. In this USA
gov. gives subsidized credit to purchaser of US agricultural products, which are to be
paid back in long periods. This is generally done for Food Aid programs, such as
(Public Law-480) under which food aid is send massively to under developed countries.
India also received this Aid in 1960’s. But this is only at concessional rates and credit
options. But this results in perpetual dependence on foreign grain in recipient
countries and destroys their domestic agriculture. So this is equally trade distorting
subsidy, which is not currently under ambit of WTO’s AOA.

There is little doubt that subsidies and support to agriculture should be controlled and
better targeted. WTO negotiations also claim to work towards this direction, but inherent
conflicting and vested interest of few countries are too influential in WTO. Many allege that
WTO’s agreement on agriculture is just a tool for neo-imperialism in hand of MNCs. Every
country has different requirements and different product mix, so enough flexibility is must
in any agreement. Further, right to food is a global movement and is guaranteed by
numerous UN conventions. So, ensuring food security is a domestic concern of a nation,
international community can just advice but can’t coerce other sovereign country. Thus,
India has to made its expenditure much more effective, with dynamic policy and resist any
outside pressure which is misdirected towards negative results for Indian people.

In last few years, due to global slowdown, there was very low Inflation (or even deflation) in
International commodity prices. At same time prices in India was reeling under double digit
food inflation. This indicates toward highly distorted agro economy not only in India, but
globally. In WTO negotiation there should be constant pressure on developed countries to
align their total subsidies to developing countries. System of Amber, blue, green box should
be considered for change and preferably it should be done away with as it gives leeway to
developed countries to carry on with distorting subsidies.

13/13