Since the Union Budget 2018-19, there has been a great deal of discussion in the public domain regarding the health of the rural sector. We believe that the rural sector needs some policy intervention, be it price support or income support. As a case in point, the agri gross domestic product (GDP) deflator has declined from 9.9% in FY13 to merely 1.1% in FY18. Such a decline also coincides with the inflation-targeting regime introduced by the Reserve Bank of India (RBI) from FY13.

Importantly, tractor sales are generally considered a proxy for better price realization for the farm sector. During FY18, tractor sales reached an all-time high of 711,000 units, around 22% higher than the previous year. However, the relationship between tractor sales and farm realizations (proxy: agri deflator) is weak as the commercial usage of tractors is increasing rapidly. Now, tractors are being used more for transportation of building material like bricks, stone plates and locally mined sand, as cost of transportation increases massively when commercial vehicles are used for this purpose. Thus, buoyant tractor sales currently are in no way indicative of the health of the rural sector.

Also, the high level of non-performing assets (NPAs) in tractor loans indicates that due to rural/agriculture distress, farmers are unable to pay the instalments irrespective of the usage of tractors.

Given that prices in the agri sector are at significantly low levels, there are three ways in which we can alleviate this, at least in the short term. The first is to provide better price for all rabi and kharif crops by fixing the minimum support price (MSP) at 1.5 times the cost of production. The second is to develop an institutional mechanism to compensate the price difference where the market price is less than MSP, such as the Bhavantar Bhugtan Yojana (BBY) adopted in Madhya Pradesh. The third is to provide agriculture investment support in the form of cash, as is being currently done in Telangana. We will analyse the pros and cons of all three schemes and suggest what could be done as a quick-fix solution to address the distress without impacting fiscal health and inflation much in the short term.

Scheme 1: Fixing MSP at 1.5x cost of production

In the Union budget, the government has announced that for FY19, MSP for the majority of kharif crops and rabi crops that are left out will be fixed at 1.5 times the cost of production. Estimates show it is based on A2+FL (actual paid out cost plus imputed value of family labour).

With the government due to announce MSP for kharif crops in FY19, we estimated what could be the projected MSP for 13 major kharif crops, based on their projected A2+FL cost for FY19 (taken at the maximum growth during FY17-FY18 for any crop), and then applying 1.5 times on it. The projected MSP for FY19 shows that the maximum increase in prices will be on niger-seed (73%) followed by ragi (58%) and jowar (42%).

Our estimate suggests that this increment in MSP by 1.5 times in kharif crops and remaining rabi crops could impact consumer price index (CPI) inflation by 71 basis points (bps). For two major crops, wheat and rice, for which the majority of the procurement is done by the government, the increase in MSP will have less impact on inflation.

This estimate is based on A2+FL cost and not on C2 cost (comprehensive cost including imputed rent and interest on owned land and capital). If the government settles on 1.5x C2 cost, the inflationary impact could be significantly large, which could even breach the RBI’s CPI target (5%) by more than 200 bps.

Scheme 2: Price compensation scheme (PCS) at all-India level

Given that MSP is only limited to certain crops, the government has also announced that it will develop an institutional mechanism in line with BBY, which has already been implemented in Madhya Pradesh (MP) for eight kharif crops in FY18.

BBY has attracted a lot of criticism, although we believe most of it was unwarranted. One, the BBY scheme in MP could benefit only 23% of production, casting doubt on how it will benefit the majority of farmers if it is scaled up at an all-India level. Second, the financial costs of ramping up BBY/PCS at the national level were estimated to be at staggering levels ranging from Rs56,518 crore to Rs1.13 trillion to Rs1.69 trillion annually depending on whether market prices are 10%, 20% or 30% below MSP, respectively. Third, there is a manipulation by traders and lower level mandi officials to depress both prices and inflate production figure (Supporting Indian Farmers: Price Support Or Direct Income/Investment Support? by Ashok Gulati, Tirtha Chatterjee and Siraj Hussain, Icrier working paper 357).

We do appreciate these concerns, but we want to negate some of the points with the available data. Post-harvest, some of the crops under BBY indeed witnessed a declining trend in prices, but this decline was not only restricted to MP. A similar trend also was seen across other states. For example, in the case of gram, prices also declined in Maharashtra, Rajasthan and Uttar Pradesh (UP). Hence, it is difficult to establish direct causation between corrupt practices/dealers at the mandi level and decline in prices of crops.

Other possible reasons for such price decline could be over-production during the post-harvest period and increase in exports due to lower global commodity prices. For example, the arrival of major kharif crops at mandis in MP for sale during the October-December 2017 period increased significantly over the comparable period in the previous year. In the case of arhar as well, the sale increased by 716% from the previous year whereas the price has declined by 47%.

One of the positives under BBY is the price support to farmers. For instance, in November 2017, the total arrival of soybean at MP mandis increased by 150% but the price declined by only 10%.

While analysing the impact of BBY on inflation, we found that under PCS/BBY, once the sales window closed, price had started to pick up (post December 2017, price have jumped). This could be avoided by either extending the sales window, which is presently October-December for kharif crops, and better administrative regulation at district level.

We also believe that the costs as per Gulati et al are overestimated, considering that the mandi prices of all rabi and kharif crops vary from state to state. In fact, in some states, mandi prices are higher than MSP for all months. So, assuming hypothetically that mandi prices will be lower by a flat 10% or 20% or 30% from MSP at the all-India level (as in Gulati) and multiplying it with net surplus value could always give an overestimated figure.

Accordingly, we estimated net surplus value state-wise and found that the total cost at an all-India level for all crops is around Rs32,302 crore. However, if states’ share is around 40%, the cost will come down further.

Scheme 3: Agriculture investment support scheme

The Telangana government has already implemented this scheme (the Rythu Bandhu scheme) to support farmers’ investment for two crops a year. The government is providing 5.83 million farmers Rs4,000 per acre per season to support farm investment twice a year, for the rabi and kharif seasons. It has made an allocation of Rs12,000 crore for the scheme in the 2018-19 state budget.

Gulati et al have estimated that the cost of this scheme would be Rs1.97 trillion if the government implemented it at an all-India level, assuming a payout of Rs10,000 per hectare per year.

But we estimated that if this scheme were to be implemented at an all-India level by providing Rs4,000 per acre per season, as specified in the Rythu Bandhu Scheme, then the financial burden could be around Rs2.7 trillion (on net sown area). If the incentive is provided on cultivated land (net sown area + fallow land in current year), the cost could even touch Rs3 trillion. Hence, the adoption of this at an all-India level would be a fiscal nightmare.

The other drawbacks of the scheme are that it ignores tenant farmers—and as the incentive is based on land ownership, implementation could raise the land price for both cultivated and uncultivated land. Further, Gulati et al have suggested removing paddy and wheat from the investment support scheme and dealing with them under the procurement scheme, which will reduce the cost significantly. But we feel that by doing so, the farmer may opt for crop diversification by allocating more area to cash crops.

The alternative

Based on the analysis of all the three schemes, we propose a hybrid of two schemes viz. 1.5 times MSP and PCS. For cereals (wheat, paddy, ragi, maize, bajra) largely procured by both Central and state governments, we should continue to procure at MSP that is 1.5 times cost of production, as the impact on inflation and the fiscal situation will be minimal. Additionally, crops like groundnut, sesamum, niger-seed and soyabean should also be covered under the 1.5 times MSP scheme, as they are procured to a limited extent (less than 10% of total production, which varies from state to state). For pulses, (arhar, moong, urad, masur and gram) and sunflower seed, we propose that PCS be implemented, as adoption under this scheme will have very little impact on inflation and fiscal cost will be Rs13,110 crore. The agriculture investment support scheme, though very easy to implement and without leakages, should be avoided given that it would be a huge fiscal burden.

We reiterate that the long-term solution to farmer distress would be improving the supply chain, establishing agro-processing zones and creating a better agri-logistic platform.

Soumya Kanti Ghosh and Debashis Padhi are, respectively, group chief economic adviser and economist, SBI. Views are personal.

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