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Economy Mar 6, 2013

UPA-nomics: How to hoard grain and let food prices soar

By Vivek Kaul

Over the last few days my mother and her sister have been complaining about how the price of a 10 kg bag of rice they buy has gone up by 17 percent in just over a couple of months.

Reuters

Food forms around 43 percent of the consumer price inflation number and so if food inflation comes down, the consumer price inflation is also likely to come down. Reuters

Now contrast this with what Akhilesh Tilotia of Kotak Institutional Equities Research writes in the GameChanger Perspectives report titled Putting the mountain of grains to use (Released on 5 March 2013). "India can raise more than Rs 60,000 crore if it prunes its inventory of foodgrains: an excess 20 million tonnes of rice and 26 million tonnes of wheat (without accounting for procurements to be made this year)," writes Tilotia. (The table shows the numbers in detail).

As the table shows below, the government currently has an excess rice stock worth around Rs 25,400 crore and an excess wheat stock worth Rs 36,300 crore, or more than Rs 60,000 crore in total. These numbers have been arrived at by taking into account the minimum support price (MSP) of rice at Rs 12.5 per kg and the MSP of wheat at Rs 13.5 per kg and multiplying them with the excess stocks.

What the table also tells us is that the government currently has an excess rice stock of nearly two times the buffer and an excess wheat stock of nearly 2.7 times the buffer.

Source: FCI, Kotak Institutional Equities Estimates

Source: FCI, Kotak Institutional Equities Estimates

The government sets MSPs for wheat and rice every year and the Food Corporation of India (FCI), or a state agency acting on its behalf, purchases rice and wheat this price from farmers. The "supposed" idea behind setting the MSP much in advance is to give the farmer some idea of how much he should expect to earn when he sells his produce a few months later. The FCI typically purchases around 15-20 percent of India's wheat output and 12-15 percent of its rice output, estimates suggest.

At least this is how things are supposed to work in theory. But most government motives have unintended consequences. With an assured price, more rice and wheat lands up with the government than it distributes through the public distribution system. Also, with FCI obligated to purchase what the farmers bring in, its godowns overflow and at times the wheat and rice are dumped in the open, leading to rodents feasting on the crop.

On the other hand, the way things currently are, it helps the farmer but it also results in pushing up market prices, since more of the grain lands up in the godowns of FCI and not in the open market.

The procurement also adds to the food subsidy. The government pays for all the rice and wheat and then lets a lot of it rot. The government currently has nearly 67million tonnes of rice and wheat in stock. Of this nearly 47 million tonnes is excess.

Tilotia expects the rice and wheat stock of the government to go up to 100 million tonnes by the time this harvest season gets over. As he writes, "After the current harvest season, Indian granaries will stock about 100 million tonnes of wheat and rice...A high inventory comes with a heavy carrying cost, which the FCI estimates at Rs 6.12 per kg for year-end September 2014: At 100 million tonnes, this will cost India Rs 60,000 crore a year (forming most of its food subsidy bill)."

A higher food subsidy bill adds to the fiscal deficit and which, as writers at Firstpost regularly keeps discussing, has huge consequences of its own. Fiscal deficit is the difference between what a government spends and what it earns.

In fact, the United States of America had a similar policy in place in the aftermath of The Great Depression of 1929 on a number of agri-commodities like wheat, tobacco, cotton, etc. The government offered a support price to farmers. This support price had unintended consequences over the years, especially in case of wheat.

As Bruce Gardner writes in the research paper "The Political Economy of US Export Subsidies for Wheat" (quoted by Tilotia): "The traditional means of price support is a governmental agreement, through its Commodity Credit Corporation (CCC), to buy wheat at the support price. This programme periodically led to governmental acquisition of large stocks which were costly to store and for which markets did not exist at the support price level."

As is happening in India right now, the American government ended up buying more and more wheat, of which it had no use for, especially at the price it was paying for it. The farmers had an assured buyer in the government and they went around producing more wheat than before. This resulted in excess stocks with the American government. Over the years this excess wheat was exported at subsidised rates.

As Gardner writes, "The subsidy ranged from 5 to 30 percent of the price of wheat, depending on world and US market conditions in each year." A lot of wheat was also donated under the Agricultural Trade and Development Act of 1954 (better known as P.L. 480) of which India was a huge beneficiary in the late 50s and early 60s till Lal Bahadur Shastri initiated the agricultural revolution.

Gradually the wheat acreage, or the area over which wheat was planted, was also reduced in the United States. This meant that the farmers had to keep their land idle and not plant wheat on it. "Acreage allotments...were reintroduced in 1954 and reduced planted acreage by about 18 million acres (from 79 million in 1953 to an average of 61 million in 1954-56). Each producer had to stay under the farm's allotment in order to be eligible for price support loans. In 1956 the Soil Bank program was introduced. It paid wheat growers about $20 per acre (roughly market rental rates) to idle an average of 12 million more acres (20 percent of preprogram acreage) in 1956-58," writes Gardner.

India seems to be heading on the same path if the current policies don't change. As Tilotia writes: "India's inventory is concentrated in the north-western states of Punjab and Haryana, which store 36 million tonnes of its 66 million tonnes of stock. Given the large procurement expected from these states again this year (though Madhya Pradesh may better Haryana in wheat procurement this year, especially given state elections), this imbalance can worsen."

Interestingly, the government can use this excess inventory of rice and wheat to control inflation and at the same time bring down its fiscal deficit. The government currently has rice and wheat worth in excess of Rs 60,000 crore. On the other hand it also has a disinvestment target of Rs 54,000 crore for the next financial year (2013-14). The government hopes to earn this amount by selling stakes it holds in public sector units to the public.

Along similar lines the government can try selling the excess rice and wheat that it currently holds in the open market. This will help control food inflation with the excess government stock hitting the market. Food forms around 43 percent of the consumer price inflation number and so if food inflation comes down, the consumer price inflation is also likely to come down.

The challenge in doing this is two-fold. The first is about moving grains from Punjab and Haryana, where more than half the inventory lies. The second is to ensure that the market prices of rice and wheat don't collapse. That would ruin lakhs of traders and kirana merchants.

Also the current MSP system is not working. If the idea is to pay the citizens of this country to improve their living standards, the government may be better off paying them in cash, rather than paying them in this roundabout manner that creates inflation. This is simply because the current system drives up the price of food for everyone else and it doesn't necessarily always benefit the farmers. The middleman continue to make the most money.

As Tilotia puts it, "If such a payment indeed needs to be made, there is no point in raising prices for all in the system by adding it to the price of the grain: Simply pay the farmer whatever support you want to pay him/her. India is reaching a situation where, by using UID it would be able to send payments to farmers directly. Maybe it is time to re-couple wheat and rice prices with global prices - that can meaningfully reduce inflation in India."

Vivek Kaul is a writer. He tweets @kaul_vivek

by Vivek Kaul

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