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Tuesday, August 09, 2022

The price is right

Centre’s criteria for MSP ensure remunerative prices for farmers with a decent margin. Arguments for MSP at 50 per cent over Cost C2 defy economic logic.

Written by Ramesh Chand |
Updated: July 6, 2018 6:31:01 pm
In reality, the MSP remained effective only for rice, wheat and cotton, where public agencies procure the produce when mandi prices fall below the MSP Illustration: CR Sasikumar

Since the beginning of the economic reforms in the early 1990s, the focus of agricultural policy has shifted towards prices. Farmers are losing faith in the market and seeking direct intervention by the government, mainly at the Centre. The situation has been aggravated by unanticipated increases in the domestic production of some crops like pulses and the low global prices of agricultural commodities, which have fallen by over 15 per cent since 2014, exerting downward pressure on domestic prices.

One way to address the situation is to use the long-tried method of direct intervention in prices through MSPs. India started the system of MSPs in the mid-1960s for wheat and gradually brought all major cereals, oilseeds, pulses, cotton, jute and sugarcane into its ambit. In reality, the MSP remained effective only for rice, wheat and cotton, where public agencies procure the produce when mandi prices fall below the MSP. In 2017-18, the central government expanded the procurement of pulses and oilseeds to an all-time high of more than 4 million tonnes to lift prices above the MSP, which helped farmers to some extent.

To address the issue effectively and comprehensively, the Union government made two significant announcements in the 2018-19 budget. It decided to keep MSPs at least 50 per cent above the sum of cost of production (A2) and imputed wages for the time spent by the farmer and his/her family (FL) in crop production. A2 is a comprehensive cost and includes paid or imputed costs of all purchased or own inputs like seed, fertiliser, manure, bullock labour and machine labour, interest on working capital, irrigation expenses, depreciation, rent paid for the leased-in land, costs of repair and miscellaneous expenses. To honour this announcement, the cabinet has approved MSPs for kharif crops for the year 2018-19. The MSPs are not only 50 per cent higher than the cost, in some cases, they are far greater. This is the best the government could do with MSPs.

Some economists have persistently criticised the government for not adopting the principle of keeping MSP at 50 at per cent above cost C2. Such an argument is neither based on logic nor does it looks into the implications of fixing MSP at 50 per cent above cost C2. Cost C2 is arrived at by adding the rental value of owned land and interest on fixed capital to cost A2 plus FL. On average, around 40 per cent of Cost C2 (imputed rent for own land and imputed value of family labour used in crop production) is not a cost but income to the farmer. Thus, if MSP is just equal to cost C2, it includes 40 per cent as net return for the farmers. No principle of economics tells us to award a margin on those costs which are not actually incurred.

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However, as own land has an opportunity cost (represented by rent), this must be covered by the MSP. It is important to mention that the MSPs approved by the Union Cabinet, based on the new criterion of 1.5 times A2+FL, have a margin over cost C2 varying from 10 per cent to 53 per cent. This clearly shows that the new criteria ensures more than 50 per cent net return to farmers over cost C2, when rent on own land and wages for family labour are treated as a return to the farmer, which indeed they are. The new MSPs announced by the government for kharif crops meet the spirit the Swaminathan Committee recommendation of 50 per cent net return over Cost C2.

Keeping MSP at 50 per cent above cost C2 involves an increase in the current MSP by 27-89 per cent for kharif and up to 45 per cent for rabi crops. Such a price entails a 50-100 per cent increase in the existing farm-level prices of some crops at one go. Demand-side factors at present do not support such a sharp increase in prices. In such a situation, private trade will not have any incentive to operate in the market and the entire onus of procuring the marketable surplus will come on the government, which in turn will be required to heavily subsidise the procured produce in order to dispose of it. This will make domestic prices much higher than global prices, which will strongly hit exports and make India attractive for imports. MSP fixed to 50 per cent above C2 will leave little incentive for efficiency and diversification in the crop sector.

A deeper analysis of crop costs reveals that keeping MSP 50 per cent above Cost A2 plus FL is adequate to ensure remunerative prices for farm produce with a reasonable margin. There is no logic and justification for raising MSP 50 per cent above cost C2 if this is not supported by demand and supply. Such a move involves keeping prices artificially high and cannot be sustained fiscally.


While it is desirable to intervene in the markets when they fail to deliver remunerative prices to producers, excessive intervention in prices can have serious implications for the functioning of market, fiscal resources and imports and exports. The best prices for farm produce can be realised from a competitive market. This requires regulatory reforms, institutional changes, and the development of appropriate infrastructure to promote evolution of agricultural market system.

A tendency is developing in the country — to hold the Centre responsible for the problems, and solutions, related to agricultural prices. The stakeholders need to differentiate areas for action by the Centre and the states. There is a particular need to put pressure on the states to undertake the required reforms to make agricultural markets more efficient, competitive and responsive to the needs of producers and consumers.

The writer is member, NITI Aayog and XV Finance Commission. Views are personal

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First published on: 06-07-2018 at 12:05:14 am
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