Farmer Insurance through Minimum Support Price

by Smeet Butala

Motivating article: https://timesofindia.indiatimes.com/business/india-business/budget-woos-farmers-government-promises-higher-msp-and-announces-multiple-farm-schemes/articleshow/62745263.cms

Introduction

India’s 2018 budget has promised, as of now, to set the minimum support price (MSP) for kharif crops at 50% above the cost of production. This is in an effort to help India’s farmers, beset by countless woes, by providing them with a source of price insurance. The budget also pledges to provide a host of schemes and mechanisms intended to help rural India. Currently included is an increase in the institutional farm credit target from ₹10 lakh crore to ₹11 lakh crore, as well as a scheme to provide crop loans to tenant farmers. The budget also lists two ₹10,000 crore funds for fisheries and animal husbandry, as well as a ₹200 crore fund for the cultivation of highly specialized medicinal or aromatic plants. The finance minister suggested providing a 100% deduction to registered Farmer Producer Companies that have annual turnovers of up to ₹100 crore. For the MSP, the government will likely continue to use the A2 formula to fix it, while many farmers’ organizations want the C2 formula to be used instead.

The A2 cost formula takes into account the cost of various inputs (seeds, labor, capital, etc.). The C2 cost formula, the comprehensive cost, includes the cost of family labor, the rent of owned land and interest on owned capital in addition to the factors in the A2 formula. Clearly, the C2 formula is almost always higher than the A2 formula, and is what various farmers’ organizations want the government to use when calculating the MSP for kharif crops; however, the government has hinted that it will continue to use the A2 formula instead, thereby setting a lower MSP and saving money for the government. The figure below contains the projections for the (current) 2017-2018 kharif season, with each value listed as the estimated cost of production per quintal and the MSP calculated on the A2 cost. For some crops, like paddy, the MSP is 84.5% over the A2, but for others, like jowar, it barely hits 40% over. And worse, we see that the MSP doesn’t even cover the C2 cost for a number of crops: jowar, ragi, moong, sunflower, sesamum, nigerseed, and cotton (Damodaran).

MSP.png
From http://indianexpress.com/article/india/the-cost-plug-50-percent-swaminathan-formula-mirage-agriculture-sector-minimum-support-price-4715922/

Minimum Support Price

The concept of the MSP is essentially a commodity price insurance for various crops, particularly kharif crops in this case. It states that, after a certain date, the government of India promises to purchase crops these crops from the producers at the prices stated, and these are stated well in advance, around the time when these crops would be planted. The purpose is to still encourage production of these necessary crops by providing a source of stable income for the farmers should the crop be bad, or should there be a bumper crop. However, due to the abysmal living conditions for farmers in India currently, the MSP has been a frequent target of farmers’ organizations, claiming that is it too low to properly support farmers in the country.

One major effect of the insurance provided by MSP is that it induces moral hazard, particularly ex ante moral hazard. Since the MSP is still a price, there must be a crop to sell, and so farmers are unlikely to be unproductive and allow their crop to go to waste. Thus, MSP still encourages hard work over shirking. However, MSP is quality-blind. A farmer could grow the lowest quality bajra possible, or the strain requiring the least number of inputs, irrespective of quality, and the government would still be bound to buy it from the farmers. Thus, the insurance that the government will indeed purchase the crops incentivizes the farmers to grow varieties with the lowest costs of production.

Another issue with MSP is that it only exists for a certain number of crops. If farmers of a certain crop, one not covered under MSP, feel that the next growing season may be too volatile, they may shift instead to a crop under MSP. This not only has the potential to flood the market for the good, it creates a skill problem. The farmers who switch to an MSP-covered crop from a non MSP-covered crop are much less likely to know how exactly to farm the new crop, and will be more likely to produce more failed crops as a result.

The MSP is also a form market intervention in the sense that it introduces the government as a consumer, and a consumer with a fixed price. This forces other consumers, particularly wholesalers, to have to compete with the government on price. In general, this implies that the prices are pushed upwards by the government intervention. Coupling this with the result of the moral hazard issue above, the prices that are set will not only be high for standard quality crops, those will be the prices for low quality crops, thus causing the market to be even more overpriced that it would nominally appear to be.

Conclusions

Unfortunately, data shows that only about 6% of farmers even benefit from MSP, and that there is widespread misinformation and lack of awareness amongst farmers: only around 24% of farmers in rural India were aware (Aditya et al). Compounding this, there are significant issues regarding storage of these crops, something that the government is often unable to properly do, thus causing the government not to accept the crops for lack of a place to store them. Compounding this with the issues listed above, there may need to be significant changes in policy or public outreach regarding MSP before it can begin to have its intended effect.

References:

Aditya, K. S., et al. “Awareness about Minimum Support Price and Its Impact on Diversification Decision of Farmers in India.” Asia & the Pacific Policy Studies, vol. 4, no. 3, 4 Sept. 2017, pp. 514–526., doi:10.1002/app5.197.

Damodaran, Harish. “The Cost+50% Swaminathan Formula Mirage.” The Indian Express, 22 June 2017, indianexpress.com/article/india/the-cost-plug-50-percent-swaminathan-formula-mirage-agriculture-sector-minimum-support-price-4715922/.

Mohan, Vishwa. “Budget Woos Farmers: Government Promises Higher MSP and Announces Multiple Farm Schemes.” The Times of India, 1 Feb. 2018, timesofindia.indiatimes.com/business/india-business/budget-woos-farmers-government-promises-higher-msp-and-announces-multiple-farm-schemes/articleshow/62745263.cms.

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Author: Econ 416 Student

Entries are contributed by undergraduate students enrolled in Economics 416: Theory of Economic Development at the University of Maryland.

One thought on “Farmer Insurance through Minimum Support Price”

  1. I did not realize that minimum support prices were a method implemented by governments in an effort to help India’s farmers feel confident in their crop’s profitability. It is interesting that other countries do not use minimum support pricing and that it has not been particularly beneficial for farmers in India either. This appears to be due to a variety of reasons, many of which you described in your blog post, but also only affects 25 out of 109 crops in India (“Minimum Support Price Scheme”, 2018). Additionally, MSP does not impact any fruits and vegetables in India, which are important nutrition staples for humans. It is clear from your article that MSP has not had the intended impact for farmers and that the government has done little to correct the associated information and policy problems. I wonder if signing off-take agreements could help solve the problem, as they would protect the farmers’ profits during droughts and other uncertainties by providing a guaranteed market for exports.

    Reference

    Minimum Support Price Scheme. (2018, March 3). Retrieved May 8, 2018, from https://www.gktoday.in/academy/article/minimum-support-prices/

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