India’s agriculture policy dilemma

In his speech at the CII National Council, Reserve Bank of India Governor Shaktikanta Das spoke about five dynamic shifts which are underway in the Indian economy. One of the five themes in the speech was “fortunes shifting in favour of the farm sector”. The speech cites record production of food grains, fruits and vegetables, and all-time high buffer stocks as “the most vivid silver lining in the current environment”. The speech also gives a policy direction for the future.

“Shifting the terms of trade in favour of agriculture is the key to sustaining this dynamic change and generating positive supply responses in agriculture. Experience shows that in periods when terms of trade remained favourable to agriculture, the annual average growth in agricultural gross value added (GVA) exceeds 3%. Hitherto, the main instrument has been minimum support prices, but the experience has been that price incentives have been costly, inefficient and even distortive. 

India has now reached a stage in which surplus management has become a major challenge. We need to move now to policy strategies that ensure a sustained increase in farmers’ income alongside reasonable food prices for consumers,” Das said.

That might not always be possible.

Favourable terms of trade along with reasonable food prices

Terms of trade will be in favour of agriculture if prices of agricultural goods are rising at a faster pace than that of non-agricultural goods. This need not be consistent with reasonable food prices for consumers. The agriculture ministry has released terms of trade data up to 2018-19. This data is given for agricultural versus non-agricultural sectors and farmers versus non-farmers. When the value of the terms of trade index is less than 100, it means that the relative prices are against farmers. The data shows that both these indices were rising in the last decade and have stagnated or fallen since.

The farmer versus non farmer terms of trade in 2018-19 was 96.4, while the agriculture versus non-agriculture index was at 106.8.

The trend is worse when it comes to the farmers versus non-farmers index. This is also the period when food price inflation growth has moderated. Food inflation shared the upward trajectory of terms of trade for agriculture when the latter was rising. This suggests that maintaining terms of trade in favour of agriculture and ensuring reasonable food prices for consumers might not be compatible.

See Chart 1: Terms of trade and food price inflation

Doing away with price support incentives

The policy of government procurement at Minimum Support Prices (MSP) has been a key pillar of India’s food security. Guaranteed remunerative prices have encouraged farmers to grow more rice and wheat. Government’s food stocks, which are built through MSP procurement, come in handy during periods of crisis such as the current one. To be sure, the policy has created problems, especially regarding ecologically unsustainable farming practices in India’s original green revolution belt. 

The policy has also created a regional imbalance. According to latest procurement data from Food Corporation of India — 2018-19 for rice and 2019-20 for wheat — 47% of total procurement was from the states of Punjab and Haryana. The share of these states in total wheat and rice production in 2017-18, the latest period for which data is available in the Centre for Monitoring Indian Economy (CMIE) database, was just 22%. 

These problems notwithstanding, the share of procurement in total rice and wheat production has been increasing continuously. Any sudden withdrawal of this policy is bound to create a huge disruption and possible disincentive for production.

See Chart 2: Share of procurement in total production

Surplus theory in Indian agriculture

The argument that surplus management has become a major challenge in Indian agriculture, logically speaking, implies that agricultural production needs to be brought down. This is definitely not a desirable solution, especially when the policy objective is to double farmers’ incomes.

How does one explain the anecdotal evidence of crash in prices with excess production. Two factors may be behind this. The first is the question of boosting food demand in India, which is still low, compared to international standards (see https://bit.ly/2X3XHAf for a detailed discussion). 

The second is what is referred to as the cobweb model effect. This pertains to production decisions based on limited information leading to wild swings in prices every year. For example, if onion prices crash this year, farmers sow lower quantities, leading to a surge in prices in the next season. This vicious cycle will repeat. The only way to break this is to improve dissemination of information regarding climatic conditions to farmers and make sure that the government does not create additional distortions in food markets. 

Resorting to imports on the pretext of controlling food inflation to prevent any spike in prices is an example of this kind of behaviour. As climate change increases the incidence of extreme weather events, affecting production, prices will probably become volatile.

Exports may provide a way out, but increasing agricultural exports may not be possible in the near future. Agriculture in developed countries is heavily subsidized, which reduces export competitiveness of third world exports. The multilateral trade regime is almost in complete jeopardy, which has significantly reduced hopes of addressing these distortions. 

These difficulties notwithstanding, there are serious questions on whether such an approach is desirable. A 2016 article by this author highlighted how India was the biggest virtual exporter of water via its agricultural exports and also among the most water stressed regions in the world (see https://bit.ly/2Eiff59 for details).

Even though it contributes less than 15% of the GDP, agriculture continues to provide livelihood to more than 40% of the country’s workers. This makes it critical for economic growth. However, to really shift the fortunes in favour of agriculture will require a demand driven sustainable policy trajectory.