Why this MSP regime doesn't help farmers

Some farmers groups have protested that the hikes are too little. The government’s defence is that these are the biggest hikes in MSP for crops such as paddy and cotton in the last few years. With this being the last agricultural season before the Lok Sabha elections next year, the issue has both political and economic ramifications. But the growing criticism that the hikes in MSP are too low every year obscures other, deeper problems with the pricing mechanism and the wider malaise affecting agriculture itself.

Lagging Inflation

In 2018-19, the average farm household earned ₹10,218 per month (at current prices), according to government data. This was just short of the national per capita income for that year, which was ₹10,495 per month. In other words, on average, a non-farm household in India is better off than a farm household.

A structural issue pertaining to agriculture is that as overall incomes improve in the economy, even if at a slow rate, food becomes a progressively smaller component of the overall household budget. So, the demand for food will, in general, grow at a slower pace than overall incomes. If farm households are not provided with income support in some manner, incomes will tend to stagnate (though there are other options open to such households such as diversifying into more lucrative cash crops).

Thus, one of the aims of the overall public procurement system was to provide farm households with a remunerative income, while balancing it with the requirement of non-farm households to access food at a reasonable price. Given that average farm incomes are below the overall average income, the public procurement system has failed in this respect at least.

On the face of it, the system of determining MSP seems set up to provide a strong income to farmers. The government determines the cost of cultivation for farmers based on field surveys across the country to figure out the actual paid out costs—wages, rent, inputs, etc. It also ‘imputes’ the value of family labour to this cost, and adds a margin of 50% to arrive at the MSP figure. Given this cost-plus approach, it seems the MSP approach is adequate to cover costs and provide an additional margin.

However, despite the claims of successive governments, MSP hikes have tended to fall short of inflation. This indicates that farm households who sell all or part of their produce to the public procurement system at MSP may not earn enough to keep pace with inflation in rural areas. In seven of the last 11 years, the increase in MSP for paddy and wheat—the most-purchased commodities by the government’s Food Corporation of India under the public procurement system—have tended to lag the rural Consumer Price Index (CPI), an overall measure of price rise in rural areas (see chart 1).

The numbers for cotton are worse, with the MSP increase being less than the CPI (rural) in eight of the 11 years. The picture for sugarcane is marginally better. States like Uttar Pradesh routinely announce their own so-called ‘state advised price’ over and above the so-called fair and remunerative price (FRP), the sugarcane equivalent of MSP. Including the state mark-up would improve the picture for sugarcane farmers.

The Reserve Bank of India has forecast inflation for 2023-24 (financial year) at around 5.1%. If this forecast holds, MSP growth will exceed inflation for 2023-24. Yet, the general point of MSP increases trailing inflation remains.

As a result, there have been several recommendations to revise the way MSP is calculated, to include other costs, including the imputed rental value of owned land, and the cost of transporting produce, etc. These have not been implemented so far.

But even when MSPs have been hiked substantially, as they were till a decade ago, the benefits have not been fully captured by ultimate producers, note Barendra Kumar Bhoi and CL Dadhich in a 2019 working paper of Indira Gandhi Institute of Development Research (IGIDR). “Until 2013-14, minimum support prices (MSP) for several farm products were hiked significantly, for five consecutive years," the authors say. “As a result, the terms of trade tilted in favour of agriculture vis-à-vis industry. However, farmers got a limited share of the improvement in the terms of trade. Bulk of the retail prices was retained by middlemen operating in the agricultural value chain. Despite improvement in the terms of trade, investment in agriculture continued to remain negligible. Large hikes in MSP seem to have raised retail prices rather than pushed up farm investment."

Coverage Issues

Even if the MSP is made more remunerative to farmers, there are other problems. One is in terms of the actual crops covered under the system. While the government announces an MSP for 23 crops (from paddy and sugarcane to copra and different dals), the bulk of procurement by government agencies is spread across just three crops—paddy or rice, wheat and cotton.

The biggest acquirer is the Food Corporation of India, which procures wheat and paddy, while the Cotton Corporation of India buys cotton. Incidentally, in the last couple of years, the government has not procured any cotton at all since market prices were well above the MSP announced and farmers found it more lucrative to sell in the open market.

Sugarcane is also a major commodity acquired under the public procurement program, though in this case, it is sugar mills, rather than a government agency, that are required to buy the commodity from farmers at the government announced FRP. Finally, for most other commodities such as dals, groundnut, and soyabean, the procurement is done by the government-owned NAFED.

According to Harish Damodaran, journalist and senior visiting fellow at the Centre for Policy Research, MSP in India has had the same limitations as irrigation. In a 2021 article, Damodaran observes: “…the benefits in both have flowed largely to farmers of a few crops and regions. MSP’s effectiveness has been a function of implementation on the ground, either through direct government procurement or forcing private industry to pay."

This is reflected in sample surveys conducted by the government among farmers. As chart 2 shows, awareness about MSP among farmers varies according to the crop—from 52% of paddy farmers being aware of the system to just 14% for growers of bajra. But even if the awareness exists, the actual proportion of farmers of a crop who sell to the relevant agency at MSP is almost always far lower.

There can be legitimate reasons for this. The actual MSP may be lower than the market price, thus giving farmers incentive to sell to private traders rather than the government. But as chart 2 shows, this is a relatively less important reason for not selling to a procurement agency. Across crops, the bigger reasons are that a buyer under MSP was not available. At a more basic level though, as the Commission on Agricultural Costs and Prices (CACP), which advises the government on MSP, noted: “Despite impressive increase in number of farmers benefitting from procurement operations during past few years, a large number of farmers are still excluded from procurement system due to lack of awareness."

The fact that the bulk of MSP procurement is skewed only toward a small range of crops has created problems of its own. Damodaran notes the close linkages between areas that have well-developed irrigation systems and MSP. “Simply put, the provision of irrigation facilities to farmers in India has induced them to plant water-guzzling cash crops," he notes. “This is due to their not wanting to ‘waste’ scarce yet assured water on growing crops solely for self-consumption. Irrigation has gone hand-in-hand with cash cropping. The existing MSP regime has further reinforced this tendency. With irrigation boosting yields and MSP purchases assuring a stable market, farmers have found it more remunerative to produce crops benefiting from both forms of support. And if this weren’t enough, these crops have also received priority by way of public breeding and research support."

Beyond MSP

The MSP, though, is just one component of what plagues agriculture and households that depend on farming as a major source of income. The bigger problem is that farming has become a completely unviable economic activity for the vast majority of the rural population, forcing them to seek work outside agriculture to supplement incomes.

According to National Sample Survey data, the proportion of rural households who are ‘marginal’ farmers (owning less than a hectare of land) rose from 69.6% in 2002-03 to 76.5% in 2018-19. Adding to this is the external environment, whether it is trends in global markets for agricultural commodities (which the CACP, in its latest report, describes as “volatile" and a “deep cause of concern") or domestic factors which have “shocked" the agricultural sector like demonetization. As Damodaran points out, this has led to risk-aversion among farmers and caused them to expand production of MSP-protected crops that are also relatively water-intensive.’ “It is clear that the existing MSP procurement regime is neither economically nor agro-ecologically sustainable," he concludes.

If this is true, where do we go from here? Damodaran is in favour of making the MSP legally enforceable, thus providing farmers with an assured price for at least the 23 crops under the public procurement system, reducing uncertainty. Promising a higher MSP margin to farmers for crops that are not as water-intensive may also provide incentives to shift away to crops that are more ecologically sustainable.

As often is the case with policy innovations (ranging from employment guarantees to mid-day meals), it is individual states that have been more enterprising than the Centre in thinking of alternatives. For example, Madhya Pradesh introduced a new scheme in 2018, Bhavantar Bhugtan Yojana, which compensates farmers for any shortfall in market prices from MSP through direct cash transfers to bank accounts, with the amount based on the quantity sold by farmers in mandis. The Centre introduced a variant of this for oilseeds.

But while reforms to MSP are sorely needed, it is unclear whether they, even in conjunction with other measures to make farming more viable, can succeed in turning the clock back to a time when rural households could live to a large extent on the proceeds of farming. The mere fact of the fragmentation of landholdings puts an upper bound on how many households can sustain themselves, even if cash transfers or other reforms were introduced, which could make farming more productive and sustainable. The simple fact is that a vast majority of rural households are not able to make a living from farming, and are unlikely to be able to do so in the future. In India, as in other countries throughout history which have grown successfully, the key is in generating viable jobs outside agriculture.

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