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LATEST NEWS UPDATES | The economics of food management by Harish Damodaran

The economics of food management by Harish Damodaran

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published Published on Sep 6, 2010   modified Modified on Sep 6, 2010


Kaushik Basu proposes a new framework for release of foodgrains from government warehouses.

Last year, official food inflation peaked at 21.05 per cent for the week ended November 28. Since then, it has eased — though the year-on-year rise of 10.86 per cent for August 21 is still in double-digit territory.

Moreover, in absolute terms, the ‘food articles' index for the latest recorded week, at 303.3, is higher than the 296.1 level for November 28. Thus, while food inflation may have declined, food prices haven't: They have actually gone up.

What makes the current episode of high food prices perhaps unprecedented is the fact that it is in spite of overflowing government granaries. As on July 1, public rice and wheat stocks of around 58 million tonnes (mt) were more than twice the required minimum buffer of 26.9 mt. It is this spectacle of ‘packed godowns' amidst ‘hungry stomachs' that has provoked even the Supreme Court to take notice.

At the heart of the mess is, obviously, flawed foodgrains management. The Government, in recent times, has been procuring more and more quantities of grain from farmers. Increased procurement has, however, not been matched by correspondingly redoubled efforts at releasing the grain where and when necessary. By doing the former well and not the latter, the Government has ended up being a net buyer from the market, while simultaneously raising the average price of food.

The mechanics of this entire process is lucidly illustrated by the Chief Economic Adviser, Prof Kaushik Basu, in a paper posted on the Finance Ministry's website (http://finmin.nic.in/WorkingPaper/Foodgrain.pdf).

Economists' approach

Economists are known for using supply-and-demand curve tools to analyse everything under the sun at the drop of a hat. Prof Basu has employed the same technique to understand the workings of India's foodgrain markets and the structure of government policy interventions. For a change, it does throw some useful light on why things have gone so wrong, while challenging entrenched positions even within the Government and Prof Basu's own Ministry.

The accompanying figure, taken from the paper, depicts a standard demand (D) and supply (S) schedule for, say, wheat. The demand for wheat rises with declining prices, just as farmers (and traders) would supply more as prices go up. If the market is left free, with no government intervention, the price will settle at P {-m}. At this ‘free market equilibrium price', a quantity of OE will be bought and sold.

Now, what happens when the Government steps in, with a view to provide grains to vulnerable consumers at below the market-equilibrium price and also guarantee a certain minimum support price (MSP) to farmers? If the Government wants to buy, it has to pay more than P {-m}; if it offers less, farmers would rather sell at the market price. In the event, it sets the MSP higher, at P {-s}, while driving up the market price as well to this level. At P {-s}, a total quantity of OA would be supplied. Of this, the Government will purchase BA and others the balance OB (which is less than OE).

The problem arises when the Government, having procured the wheat, decides on its offloading. The prevalent practice has been to offer grain from the Food Corporation of India's (FCI) stocks at above its purchase price, covering the MSP plus transport and sundry costs. This strategy, Prof Basu argues, makes little sense. Why should a miller pay above P {-s}, when he could well buy at P {-s}, which is now the market price? If the Government is really keen to sell, it should make the grain available at or below P {-s}.

Why is it not doing so? The answer stems from the mistaken belief that since the FCI is already issuing substantial grains to the poor at below even P {-m}, it needs to cut some of these losses by selling at above the acquisition cost to non-poor consumers. But then, by trying to sell at a price at which it is unable to sell at all, the fiscal burden on the Government would only be greater, as the cost of procurement is a ‘sunk' cost. If the Government genuinely wants to pay farmers more than P {-m} and, at the same time, supply wheat to the poor at below Pm, it has no choice but to incur a fiscal cost, which is BA multiplied by P {-s} - P (where P covers a range of prices below P {-s}).

Release, the key

The key to sustain such an operation, Prof Basu notes, lies in managing grain releases. Given that the effect of Government procurement is to raise market prices beyond the normal equilibrium level (P {-m}), corresponding efforts are necessary to release grain back into the system. In bad crop years — when the aggregate supply curve shifts leftwards, leading to a higher P {-m} — the FCI should ideally not buy at all. This can be done by keeping the MSP unchanged, so that P {-s} is below P {-m} and farmers are encouraged to supply mainly to the market. This, combined with more releases from public stocks, will help stabilise open market prices.

The current system, by contrast, makes the Government a net buyer in all times — whereas it ought to be procuring only during the immediate harvest period (so that farmers solely benefit) and largely in bumper crop years. The release window, on the other hand, should be open round the year.

Prof Basu suggests that the Government must not excessively monitor where the released grain is going and whether traders are making a killing in the bargain. A better way is to release grain from FCI godowns in small quantities to large numbers of millers and traders, and giving them the freedom to make profits. Competition will drive the prices down through natural market forces.

The ultimate aim is to ensure that the grain procured by FCI goes back into the system and the Government does not become a hoarder, which it is today. Point taken, Professor. But can you get your Minister and other higher-ups to agree?

The Hindu, Business Line, 6 September, 2010, http://www.thehindubusinessline.com/2010/09/06/stories/2010090650330900.htm

Tagged with: Food Security



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