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One way to reduce price risk is through price deficiency payment, which has been advocated by Niti Aayog. Illustration: Jayachandran
One way to reduce price risk is through price deficiency payment, which has been advocated by Niti Aayog. Illustration: Jayachandran

The difficult economics of the Indian farmer

Policy should focus not just on higher production but also on helping farmers manage risks

Anybody who is dismissive of the wave of farmer protests across the country should first understand the difficult everyday economics of the Indian agriculturalist. Most farmers swim in a turbulent sea of risks against which they have almost no protection.

The risks begin with sowing. The production in the months ahead is deeply dependent on weather conditions. It is not just about the extremes of drought or flooding. Even a round of unseasonal rain can destroy standing crop. Irrigation can offer some respite—but not to the extent of completely removing production risks.

Then comes the price risk. A bumper crop can pull down prices in wholesale markets. Price spikes after a poor crop are inevitably dealt with through cheap imports in a bid to protect consumers. The opposite is done less frequently. The bountiful rains of 2016 resulted in record farm output. Prices crashed. Farmers are reported to have not been able to even recover the cost for some crops. The prospects of a good monsoon pushed up rural wages. The reality of rock bottom prices then destroyed profit margins. Also, economists at HSBC showed in a recent report that the fall in inflation has increased the real debt burden of farmers, which has risen faster than real income in recent years.

The opportunities for risk mitigation are minimal. Successive governments have taken steps to reduce the risk faced by farmers. The entire paraphernalia of minimum support prices (MSPs) was originally conceived as a way to mitigate risk through guaranteed prices. It later degenerated into a tool to buy the political support of large farmers. The Narendra Modi government in 2016 launched the Pradhan Mantri Fasal Bima Yojana, a potential game changer. However, as reported by this newspaper, farmers who suffered losses in the last financial year have not yet received compensation for 55% of the estimated claims under the scheme. Crop insurance will not benefit farmers as desired if the compensation is not paid in time, as they will need the money for sowing in the next season. The government would do well to remove inefficiencies in the system.

A more robust mechanism is needed to mitigate the price risk. The lack of future prices means that farmers base their production decisions on prices at the time of sowing. Their price expectations are thus adaptive rather than forward-looking. The standard cobweb model in microeconomics helps us understand why production decisions based on limited information lead to wild swings in prices every year. Tomatoes are the most recent example.

In 2016, the government encouraged farmers to produce pulses because of rising prices, part of the protein inflation that the Reserve Bank of India used to be obsessed with. The farmers responded. Record output led to a price crash. Market prices went below the support prices.

One way to reduce price risk is through price deficiency payment, which has been advocated by NITI Aayog. In price deficiency payment, farmers can be compensated through direct benefit transfer if prices fall below a predetermined threshold level. For this, farmers may be asked to register with relevant details at the nearest mandi. A deeper derivative market in agricultural commodities will also help farmers in hedging against price risks. The market regulator has done well by allowing option contracts. However, the government should avoid its Pavlovian response of banning trading whenever prices rise.

There are other issues as well. For example, gross margin in the MSP recommendations by the Commission for Agricultural Costs and Prices looks higher on the basis of “actual paid out cost plus imputed value of family labour", which does not account for forgone interest and rental for owned capital and land. Once these are included under the “comprehensive cost including imputed rent and interest on owned land and capital", returns sometimes turn negative. Also, the price mechanism is suppressed. Ad hoc policies often don’t allow farmers to take advantage of export opportunities. Shweta Saini and Ashok Gulati in a recent study, Price Distortions In Indian Agriculture, showed that domestic prices for 15 commodities between 2004-05 and 2013-14 were below export parity prices on an average 72% of the time. The study notes: “In most years, for the majority of agri-products, the policymakers used restrictive export policies to keep domestic prices low. This showed the pro-consumer bias in the policy complex."

Protecting consumer interest in general is the right thing to do for any government. However, in areas where markets don’t function freely, it needs to strike a balance between the interests of both the producer and the consumer. The actual impact of higher remunerative farm prices can be contained by making markets more efficient and removing middlemen from the system. Building a common agriculture market is also necessary.

Farming is a very risky affair. Government policy should focus not just on higher production but also on helping farmers manage risks.

What should the government do to improve farm income? Tell us at views@livemint.com

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