Transfin.
HomeNewsGuidesReadsPodcastsVideosTech
  1. Reads
  2. Deep Dives

What is MSP? How Does MSP Work? What Will a Legal Gurantee on MSP Involve?

Editor, TRANSFIN.
Dec 8, 2021 5:50 AM 7 min read
Editorial

Recently, both Houses of Parliament passed a bill to repeal the three contentious farm laws that sparked a year-long agitation by farmers across the country, especially those in Punjab, Haryana and western UP.

We've already covered the pros and cons of the farm laws, why opposition was particularly vociferous in some states, and why the Union Government opted to walk back on reforms it once described as “historic” and “revolutionary”.

Now, while news of the laws' roll-back was welcomed by the protesting farmers at Delhi's borders, many still considered it a "half-victory". Last week, farmer unions released an open letter to PM Narendra Modi, listing six key demands. The most important among these - indeed, a key point raised by protestors since last year - involves providing a legal mandate for the Minimum Support Price (MSP).

What is MSP?

The agri supply chain begins at local marketplaces or mandis, where farmers sell their produce to buyers who quote the highest price for the same.

The MSP is a mechanism whereby the Government announces (at the beginning of the sowing season) the minimum price at which it will buy a farmer’s harvest.

Fixing MSPs is seen as necessary to protect farmers from price fluctuations, set a base price that offers adequate remuneration to the farmers, and give them an upper hand in mandi negotiations. If middlemen try to dupe the farmer by quoting low rates, the farmer can always sell their produce to the State through procurement agencies like the Food Corporation of India (FCI) - agencies that are required by law to purchase from the farmer at the MSP.

The MSP system began in the 1960s, when GoI wanted to incentivise farmers - mainly in the Punjab-Haryana belt - to grow paddy and wheat to overcome a looming food shortage crisis. In the coming years, the Green Revolution took root and, fast-forward six decades, the country constantly reports surplus harvests, even during drought years.

The Green Revolution, MSP and other agri reforms over the years have been credited with making India more or less self-sufficient in agriculture. (Well, largely - there is still work to be done. Case in point: edible oils.)

 

How Many Crops are Covered Under MSP?

Presently, the Union Government sets an MSP for 23 crops based on the recommendation of the Commission for Agricultural Costs and Prices (CACP).

These crops include seven cereals (paddy, wheat, maize, bajra, jowar, ragi and barley), five pulses (chana, arhar, moong, urad and masoor), seven oilseeds (rapeseed-mustard, groundnut, soyabean, sunflower, sesamum, safflower and nigerseed), and four commercial crops (sugarcane, cotton, copra and raw jute).

FYI: An important point to note here - MSP is grossly skewed, geographically speaking. While GoI procures a third of the wheat and rice harvest annually at MSP, half of this is from Punjab and Haryana alone. It is also an imperfect system, reaching only about 14% of land-owning farmers (2.1 crore beneficiaries in FY21). Even among crops, the system is more rigorously implemented for only about four - paddy, wheat, cotton and sugarcane.

 

How is MSP Calculated?

The CACP fixes each season's MSP based on an array of factors - domestic and international prices, monsoon regularity, inter-crop price parity, supply-demand dynamics etc

While the MSP formula has evolved over time, its objective has always been to ensure farmers a guaranteed profit and economic stability. After all, agriculture is a sector that employs half the workforce and is the bread-and-butter of rural India. MSP has also become all the more crucial in helping achieve social development targets - like the goal to double farmers' incomes by 2022.

Since 2018, the prevailing calculation has been MSP = 1.5 x (A2 + FL).

Which translates to 1.5 times of the “production cost”, which is the sum of paid-out costs for seeds, pesticides, fertilisers, irrigation, hired hands etc. (aka A2) and the cost of unpaid family labour (FL).

Interestingly, while the “production cost” formula was based on the recommendations of the Swaminathan Committee (as a “predetermined principle”), the original report of the Committee suggested that MSP be made equal to “at least 50%” more than the weighted average cost of production (aka C2).

The C2 formula - a popular demand among farmers - takes into account the parameters under “production cost” in addition to things like rent and interest accrued on the land and machinery used during cultivation. If adopted, it would change (aka increase) MSP thus: MSP = 1.5 x C2.

 

What is a Legal Guarantee of MSP?

Basically, this involves enshrining MSP into law.

Currently, MSP is set by GoI regularly as a matter of policy and precedent, not because it is legally obliged to do so - simply because there is no law regarding MSP.

 

What a Legal MSP Could Look Like

There are three possible scenarios.

One, private players would be required by law to purchase crops at MSP (or above).

Two, the Government itself spearheads procurement operations via agencies like the FCI, National Agricultural Cooperative Marketing Federation of India (NAFED), Cotton Corporation of India (CCI) etc.

Three, private players are free to quote whatever rates they think are best and, if the rates are below MSP, the Government compensates the farmers for the difference. Basically, price deficiency payments.

 

Pros of a “Legal MSP”

Farmer unions say MSP “should be made a legal entitlement for all agricultural produce, so that every farmer of the country can be guaranteed at least the MSP announced by the Government for their entire crop”.

Proponents of embedding MSP into law argue that while the conventional MSP formula theoretically guarantees a 50% return for farmers, actual remuneration received by farmers is much lower since the minimum prices are arbitrarily set by the State and farmers cannot demand them as a matter of right. Giving MSP a legal mandate could thus raise farmers’ incomes and alleviate much of the stresses that assail Indian agriculture.

Moreover, if an MSP for non-paddy crops is assured, the Government could effectively encourage farmers to abandon monoculture and embrace crop diversification. Punjab and Haryana could branch out from water-intensive crops like rice, which isn’t even a staple of the region. Issues with dwindling underwater reserves, soil health and stubble burning (linked to paddy) could also be addressed.

 

Cons of a “Legal MSP”

These can be classified under three headings - practicality, fiscal costs and infrastructural challenges.

All three possible scenarios of what a legal MSP could look like (listed above) come with potential caveats. In scenario #1, cajoling private players to buy above a base price would (1) entail undue Government intervention in the market, (2) turn away many buyers, (3) lead to a lot of food wastage as buyers might opt to purchase only the top-quality crops, and (4) lead to an escalation in food inflation.

The other two scenarios involve overwhelming Government procurement. But it's not "the Government'' that foots the MSP bill - it's you and me. The MSP value of the total output of all the 23 notified crops in FY21 was c. ₹11.9Lcr ($158.49bn). Now, not all of this was marketed - much of the produce is often reserved by farmers for self-consumption or to feed cattle. If you assume that 75% of yields was procured by the State under MSP, that’s a bill of about ₹9Lcr ($119.87bn).

Now, if MSP is made a rule rather than a norm, the bill could balloon to ₹17Lcr ($226.41bn) (Government estimate). To put that in context, that’s half of the country’s annual expenditure. Needless to say, that’s a lot of money. To quote a member of the farm law panel set up by the Supreme Court, a legal MSP guarantee “will drive the country to bankruptcy”. It could also open a Pandora’s box of sorts and lead to demands for MSP in other crops, fruits and vegetables.

Then there are the infrastructural challenges. Due to the existing MSP system, the stock of paddy, wheat, and other crops with the Government is often more than double the minimum buffer stocks. And the rate of procurement is increasing: in 2014-19, for instance, NAFED procured 91 lakh tonnes of oilseeds and pulses at MSP, up 1205% vis-a-vis the 7.02 lakh tonnes it procured between 2009-14.

India’s food storage infrastructure capacity is limited and in dire need of modernisation. Case in point: cold storage deficiencies earlier last year. Or simply the strange and sinful contradiction of a country that regularly posts surplus harvests also being a country ranked a measly 101 on the Global Hunger Index, where citizens routinely die of starvation in the 21st century despite sweeping Government programmes (Public Distribution System (PDS), Food Security Act, Garib Kalyan Anna Yojana etc.) in place meant to avoid exactly that.

 

Would A “Legal MSP” Be A New Concept?

Sort of. Simply because nothing of this scale has ever been tried on a national level in India.

That said, there is some precedent.

One is in the sugar sector, which already has a legal MSP of sorts. Private mills are required by law to buy produce from cane farmers at set prices. Over the years, though, faced with surplus stocks, low prices and limited liquidity, mills have failed to make regular payments, which has resulted in a lot of dues. (The sugar subsidies also don’t go down well at the WTO.)

The second precedent is Maharashtra, where the state government (interestingly, a BJP-ruled one) in 2018 amended the APMC Act to penalise “any trader who fails to purchase farm goods at MSP” with a jail term of a year or a fine of ₹50,000 ($666). Consequently, buyers either only bought the top-quality produce or withdrew from the market altogether, leading to the move to be soon abandoned.

FIN.
 

Congratulations! You've made it to the end. Looking for more takes on Business, Finance, Markets and Investing? Subscribe to TRANSFIN. E-O-D for informative and insightful daily news updates