Why food prices will rise even with record procurement

Despite record stocks in the FCI's godowns, the market prices of wheat and rice will not come down due to government-created distortions

Vivek Kaul May 13, 2013 17:13:52 IST
Why food prices will rise even with record procurement

When the production of any commodity goes up, its price falls.

That's Economics 101. But economics is not physics. And what sounds true may not be true.

Take the case of the report in The Times of India dated 12 May 2013 which points out that the "US agricultural department and...the Food and Agriculture Organisation (FAO) have predicted record global output of cereals...raising hopes of snapping the trend of worryingly rising food prices."

The US department of agriculture expects the global production of wheat to rise by 6.9 percent to 701 million tonnes in 2013-2014 from the previous year. The production of rice is expected to rise by 1.9 percent to 479 million tonnes.

This rise in production, the newspaper says, will bring down cereal prices in particular and food prices in general. The cereal inflation was 4.62 percent in March 2012. But it had shot up to 18.36 percent in March 2013.

Will this inflation come down? Another reason in favour of increased production is the fact that the India Meteorological Department has said that the South West Monsoon will be normal this year. The South West Monsoon is very important for the production of rice given that half of India's area under cultivation is still at the mercy of monsoons. Irrigation, or wherever its available, is also dependent on rainfall.

While an increase in the production of a commodity does have an impact on its price, there are other bigger factors at play in the Indian case. Every year the government of India sets a minimum support price for rice and wheat. At this price, it buys rice and wheat from farmers through the Food Corporation of India(FCI) and other state government agencies.

This price is declared in advance in order to give the farmer an idea of what he is likely to get for his produce. While the idea behind MSP is noble, it has essentially become a tool of giveaways in the hands of politicians. The MSPs for both wheat and rice have been raised dramatically over the last few years.

In 2009-10, the MSP for rice paddy was Rs 1,000 per quintal (i.e. 100 kg). This was increased to Rs 1,250 per quintal in 2012-2013. For wheat, this went up from Rs 1,080 per quintal to Rs 1,350 per quintal.

So MSPs have gone up dramatically over the last few years. This has resulted in more and more rice and wheat being produced and landing up with the FCI and other agencies which operate on its behalf. The way the current system works is that the FCI is obligated to buy all the rice or wheat that the farmer wants to sell as long as a certain quality standard is met. This has led to a situation where farmers find it favourable to produce rice and wheat because they have a ready buyer for all their produce, at a price they know in advance.

The net result is that the stock of rice and wheat with the government has gone up dramatically. At the beginning of 1 March 2013, the total rice and wheat stock stood at 62.8 million tonnes. Now compare this with the minimum buffer of 25 million tonnes that needs to be maintained. So the government is buying much more rice and wheat than it actually needs to maintain a buffer and distribute through its various social security programmes.

As an article in the 26 May 2013 edition of Business Today points out, "A few years of high minimum support price (MSP)...has led to massive procurements. This, however, has not been followed through with regular releases into the market." So the prices of rice and wheat have gone up, as more of it lands up in the godowns of FCI and not in the open market. Or, as Madan Sabnavis, Chief Economist at credit rating agency CARE told Business Today, "Excess procurement is leading to an artificial scarcity."

This is something even the government agrees with. A December 2012, report brought out by the Commission for Agricultural Costs and Prices, which comes under the Ministry of Agriculture says that "Since 2006-07, the procurement levels for rice and wheat have increased manifold...Currently, piling stocks of wheat with FCI have led to an artificial shortage of wheat in the market in the face of a bumper crop. Wheat prices have gone up in domestic markets by almost 20 percent in the last three months alone (in the three months up to December 2012, when the CACP report was released), because of these huge stocks with the government that has left very little surplus in markets."

The procurement of foodgrains increased from 34.3 million tonnes in 2006-2007 to 63.4 million tonnes in 2011-2012. Due to this the total stock of food grain in the central pool went up from 25.9 million tonnes as on 1 June 2007 to 82.4 million tonnes on 1 June 2012. The total stock that is held by FCI, state governments and their agencies is referred to as the central pool.

As on 1 March 2013, this number stood at 62.8 million tonnes. Analysts expect this to touch 100 million tonnes after the current procurement season gets over. FCI estimates put the carrying cost for this inventory at Rs 6.12 per kg. At 100 million tonnes, the cost works out to over Rs 60,000 crore.

And all this has happened because of high MSPs being set by the government. What is interesting is that the Comptroller and Auditor General (CAG), in a recent report titled "Performance Audit of Storage Management and Movement of Foodgrains in Food Corporation of India (FCI)" questions the logic behind how the MSPs are being set.

The report was presented to Parliament on 7 May 2013. As the report points out, "No specific norm was followed for fixing of the Minimum Support Price (MSP) over the cost of production. Resultantly, it was observed the margin of MSP fixed over the cost of production varied between 29 percent and 66 percent in case of wheat, and 14 percent and 50 percent in case of paddy during the period 2006-07 to 2011-12. Increase in MSP had a direct bearing on statutory charges levied on purchase of foodgrains by different state governments... All this resulted in raising of the acquisition cost of foodgrains."

Why food prices will rise even with record procurement

Over the last few years high MSPs have motivated various state governments to set up more and more procurement centres. Reuters

The high MSPs have led to another distortion. FCI procures its rice and wheat from states like Punjab and Haryana. But over the last few years high MSPs have motivated various state governments to set up more and more procurement centres. A good example is Madhya Pradesh, which emerged as the second largest procurer of wheat last year by having set up more procurement centres over the years and by also offering a bonus to farmers over and above the MSP. This year Bihar seems to have got into the act. As a recent editorial in Business Standard points out "Bihar, only a marginally wheat surplus state, has this year set up more grain procurement centres than the major wheat-growing states of Punjab, Haryana and Uttar Pradesh put together."

So the moral of the story is that both the central and state governments are procuring a bigger proportion of the rice and wheat that is being produced, distorting the market totally. As VS Vyas, an economist with the Prime Minister's Economic Advisory Council, told Business Today: "Stock in the market is important, not the total stock."

It is unlikely that MSPs are going to come down this year given that Lok Sabha elections are due next year. The Congress-led UPA may be tempted to offer above market rates for grains even though the granaries are full. And even though the global production of rice and wheat is likely to go up, there will be no relief for the Indian consumer.

Vivek Kaul is a writer. He tweet @kaul_vivek

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