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The Wheat Market: Distortions Caused by Government Interventions

Wheat stocks are rising again, well beyond the minimum required, and a large procurement is expected from the 2009-10 wheat marketing season that begins on 1 April. India appears set once again for yet another phase of rising stocks, mounting carrying costs, and a crisis of plenty. The volatile cycles of rising and falling stocks appear to be the result of poor government intervention, in particular, poor procurement policies. It is argued here that unidirectional revisions in the minimum support price create serious demand and supply imbalances and extreme volatility in buffer stock cycles.

Wheat stocks are rising again, well beyond the minimum required, and a large procurement is expected from the 2009-10 wheat marketing season that begins on 1 April. India appears set once again for yet another phase of rising stocks, mounting carrying costs, and a crisis of plenty. The volatile cycles of rising and falling stocks appear to be the result of poor government intervention, in particular, poor procurement policies. It is argued here that unidirectional revisions in the minimum support price create serious demand and supply imbalances and extreme volatility in buffer stock cycles.

INSIGHTmarch 21, 2009 vol xliv no 12 EPW Economic & Political Weekly42varied between Rs 479 and Rs 747 per quintal as against the average price of Rs962 paid for imports during 2006-07 and Rs1,480 during 2007-08. As there was a whopping difference between the price paid for imports and the price earned from exports (Rs 215 per quintal between 2005-06 and 2006-07 and Rs 724 between 2006-07 and 2007-08), it was argued that some stock should have been carried forward to meet a future contingency instead of exporting it at a cheap and subsidised rate. The story of the buffer stock cycle did not stop here. Wheat stocks again suddenly shot up to 24.4 mt on 1 July 2008 and to 22 mt on 1 October 2008, which are approximately double the stock levels on the same dates in the preceding year.The average level of stocks during the agriculture year 2008-09 is estimated to be more than double the norm. The stock situation as on 1 January 2009 was 18.2 mt and the government may end up with more than 14 mt of wheat stocks on 1 April 2009, against the norm of 4 mt. If wheat output turns out to be close to normal, the prevailing market situation is likely to compel the government to go for large-scale procurement of wheat, as the private sector would not find it very attractive to buy wheat at the minimum support price (MSP) announced by the government. This would then take the buffer stock closer to the levels seen during 2001-03. With the international prices of wheat on a down-ward trend and lower than the MSP, the export window for reducing stocks is almost closed. If the country chooses to provide an export subsidy to wheat, as was done during 2002-04, it would amount to subsidising foreign consumers at the cost of Indian taxpayers while at the same time depriving domestic consumers. The moot point now is why have buffer stock cycles become so volatile during the last 10 years and can something be done to moderate them and restore the balance between demand and supply? In order to explore this, we need to examine govern-ment intervention in the wheat market mainly through the MSP. This is attempted in the next section.2 Minimum Support PricesThe distinction between theMSP and pro-curement price was abolished long ago and the government now procures foodgrains only at theMSP. This implies that theMSP serves two purposes (a) as a check against the price falling below a floor, and (b) meeting the procurement target determined by the government.As the government purchases a signifi-cant quantity of wheat in the harvest sea-son, theMSP has a very strong influence on the open market price not only in the harvest season but in the entire year. Therefore, theMSP also strongly influenc-es the scale of operations of the private sector in the market. The common percep-tion about the MSP is that it is fixed, based on the level of cost of production. A lot of debate has gone into this aspect and over time some new items have been suggested as required to be considered in the deter-mination of the MSP.In the cost of cultivation parlance, “C2 cost” is considered a relevant concept for theMSP. This includes all actual expenses in cash and kind, rent for leased-in land, and imputed values of the cost of family labour, owned capital assets, depreciation, the interest on fixed and variable capital, the rent for owned assets. A fairly large percentage of this cost, in fact, return to the producers. The MSP based on the cost of production has two big advantages. One, it ensures that the producers do not suffer a loss and they get a price that is re-munerative. Two, the cost of production (COP) also captures the market trend to the extent this trend is reflected in the wage rate and the input prices. As per its terms of reference, the Commission on Agricultural Costs and Prices (CACP) takes into account several factors, apart from theCOP, in formulating the recommenda-tions on the MSP. These include price parity, demand and supply, the effect on the industrial cost structure and the cost of living, the international price situation, the effect on issue prices and the implica-tion for food subsidy.It would be interesting to see the level of MSP relative toCOP, and how the two series have moved over time. Till 1998, the MSP remained very close to what theCOP of wheat was. The MSP largely stayed slightly higher, but occasionally it fell a bit below than theCOP.1 However, after 1998 theMSP for wheat started deviating from COP in an upward direction and a large gap developed between the two (Figure 3, p 44). The correlation coefficient between theCOP and the MSP of wheat normalised by the Consumers Price Index for Agricul-tural Labour (CPIAL) was 0.62 during 1980-81 to 1996-97 and it declined to 0.12 after 1996-97, which was not statistically significant. In the same periods the cor-relation between domestic and inter-national price of wheat (US HRW wheat FOB price) expressed inUS$ increased from 0.27 to 0.92. Juxtaposing Figure 3 on Figures 2 and 1, shows that as long as the MSP was an-chored to the COP, the buffer stock and the net trade in wheat followed a relatively mild year to year fluctuations (refer to the period 1980-81 to 1997-98). The periods during which the MSP for wheat deviated from the COP, the buffer stock cycles and trade cycles became violent. In other words, as long as the MSP was kept close to Table 1: Buffer Stock of Wheat in Different Years (million tonnes)Year 1 January 1 April 1 July 1 October Average for AgriculturalYear1981 5.0 3.1 7.7 6.2 1982 5.2 4.5 10.28.6 5.91983 7.25.613.012.0 7.91984 10.7 9.617.816.6 11.31985 14.712.520.718.6 15.41986 15.110.318.9 16.9 16.21987 14.1 9.514.911.5 14.91988 7.6 3.3 7.6 5.9 9.31989 4.7 2.7 9.4 7.9 5.21990 6.0 3.7 13.211.7 6.71991 9.6 5.8 9.7 7.5 10.11992 5.3 2.2 6.5 4.4 6.21993 3.3 2.7 14.9 13.7 4.21994 10.8 7.017.515.6 11.61995 12.9 8.719.216.9 13.71996 13.1 7.814.110.5 14.31997 7.1 3.2 11.48.3 8.71998 6.8 5.1 16.515.2 7.91999 12.7 9.7 22.520.3 13.52000 17.213.227.826.9 18.32001 25.021.538.936.8 25.32002 32.426.041.135.6 33.52003 28.8 15.624.218.4 30.32004 12.7 6.919.114.2 15.62005 8.94.014.510.3 11.62006 6.2 2.08.26.4 8.32007 5.44.712.910.1 6.22008 7.7 5.8 24.422.0 9.12009 18.2 12.9* 19.4Norm 8.2 4.0 17.111.010.07* Press release,23 January 2009, Press Information Bureau,GoI. Sources: Bulletin on Food Statistics, GoI, New Delhi, various issues,Economic Survey, GoI, New Delhi, various issues.
0 10 20 30 40 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
1980-81 1983-84 1986-87 1989-90 1992-93 1995-96 1998-99 2001-02 2004-05 2007-08 5 3 1 –1 –3 –5 –7
120 140 160 180 200 220 240 260 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 MSP/CPIAL COP/CPIAL
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 MSP International price

central government issued the “Removal of Licensing Requirements, Stock Limits and Movement Restrictions on Specified Foodstuffs Order, 2002” on 15 February 2002, allowing dealers to freely buy, stock, sell, transport, distribute, dispose, etc, any quantity in respect of wheat, paddy/rice, coarse grains, sugar, edible oilseeds and edible oils without requiring any l icence or permit therefore under any order i ssued under the Act. This was followed by a launch of the futures trading in wheat and rice in 2003. A nother important step taken up by the central government and various state government was to adopt Model APMC Act, which facilitated a

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