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Students Corner - A Decade of Economic
Reforms in India - A Review

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The monetary implications of increasing food stocks emanate essentially from the increasing procurement of foodgrains. The higher demand for food credit can give rise to possible crowding-out effects on other sectors. It can also affect the interest rate and the credit risk profile of the banking system arising out of deteriorating quality of foodgrain stocks, which act as collateral for food credit. As a result of unprecedented rise in foodgrain procurement operations, food credit registered a marked uptrend from Rs.4,506 crore as at end-March 1991 to Rs.53,978 crore as at end-March. Consequently, the share of food credit in total commercial bank credit has increased from 3.9 per cent to 9.2 per cent during the same period.

Given the persistence of significant deficit on the revenue account of the Central Government, any increase in food subsidy (caused by increasing procurement) implies equivalent increase in market borrowing by the Central Government. Furthermore, the higher demand for resources may engender a tighter liquidity position, particularly during conditions of strong economic activity, which in turn could affect the interest rate. If monetary conditions were to remain unaffected, banks would have to raise additional resources through refinance or reallocate existing assets in order to meet the higher non-food credit demand. Presently, refinance from the Reserve Bank is not allowed against food credit. In the absence of any food credit refinance facilities, banks may reduce their holding of government securities, which could imply higher holding of securities by the Reserve Bank, increasing thereby the monetary base indirectly. This would lead to reserve money expansion and, ceteris paribus, would result in an increase e in money supply over the medium-term through the money multiplier process with possible inflationary effect. Since food credit is provided out of the lendable resources of banks, any further increase in non-food credit demand would reduce the resources available to banks for lending to other sectors thereby exerting an upward pressure on interest rates (Box III.1).

Apart from the monetary implications, growing food stocks have fiscal impact, arising from the growing food subsidy and its concomitant impact on the revenue deficit of the Central Government. The food subsidy is the operational deficit in the economic cost of foodgrain operations on one hand and the income accruing to the FCI through sales under PDS, open market sales including exports, and other welfare schemes at issue prices fixed by the Government on the other. The food subsidy rose moderately from Rs.2,450 crore in 1990-91 to Rs.5,377 crore in 1995-96 and then rapidly to Rs.17,499 crore in 2001-02 and accounted, on an average, 4.1 per cent of Central Government expenditure.

The food subsidy comprises two components: consumers’ subsidy and the subsidy pertaining to the carrying cost of buffer stock. The carrying cost is the cost incurred by the FCI for inventory management, while consumer subsidy is food subsidy net of carrying cost. The amount of consumer subsidy depends on the volume of foodgrains distributed through the PDS and the carrying cost is determined by the volume of the inventory with the FCI.8 While carrying cost on maintaining the stocks at buffer norm levels is a price for food security, the carrying cost on excess stocks over and above buffer norms may be considered as a kind of implicit producers’ subsidy.9 In other words, if the stocks were to be maintained at the levels of prescribed norms, given the off-take, procurement would have to be less by the extent of excess stocks and hence, lesser total outgo in terms of carrying cost. In recent years, the share of carrying cost for excess stocks over and above norms (i.e. , the implicit producers’ subsidy) in total food subsidy far exceeded that of the consumer subsidy.

The composition of food subsidy has, over the years, evolved in such a way that implicit producers’ subsidy emerged as the largest component (48.9 per cent in 2001-02 from 12.8 per cent in 1993-94) with a corresponding erosion in the share of the consumer subsidy (29.2 per cent in 2001-02 from 56.5 per cent in 1993-94) and subsidy pertaining to maintaining the stocks at the buffer norm levels (21.9 per cent in 2001-02 from 30.7 per cent in 1993-94). This implies that a larger portion of the subsidy is being spent on carrying costs, rather than on meeting the original aim of subsidising the consumers through the PDS.

Food procurement operations of the FCI also imply contingent liabilities for the Central Government. The food credit outstanding must always be fully matched by the value of paid stocks of foodgrains, evaluated as per the banking norms. In this connection it raises concern regarding the procedure for evaluating the quality and quantity of stocks (which act as collateral for the extension of food credit by virtue of their marketability), as these will have an impact on the quality of outstanding advances of commercial banks. This becomes crucial in the light of the finding that on an average 10 per cent of the annual production of foodgrains is wasted annually on account of inadequate storage facilities (Radhakrishna et al, 1997). As food credit is government guaranteed, deterioration in the quality of food stock, in the final analysis, implies a further loss on the Government account as these guaranteed stocks result in cash outflows (in terms of food subsidy) in the budget, which is the fiscal impact of growing stocks (Box III.2).

It may be noted, however, that the stocks have been on the decline since 2001-02 mainly due to persistent efforts made by the Government to increase off-take primarily through exports. The reduction in CIP for APL consumers in July 2001 had also resulted in some improvement in the off-take on the TPDS front. The strategy of increasing exports at the BPL prices can at best be sustained in the short-run only, as the exports depend on various factors other than the prices of the grains. As for the immediate future, the first half of 2002 has seen grain prices rise largely due to adverse weather conditions in the United States, Canada and Australia. The price increase in the near term, however, seems limited due to higher competition from other producers such as Argentina and Brazil and the restoration of export subsidies by the European Union (IMF, 2002). Further, the US Farm Bill, which aims at increasing price support and expanding support to new crops, may also dampen the prospects of sustained increases in the prices of foodgrains. The world price scenario that may prevail in the long run is not clear. Relying on exports of foodgrains, therefore, could only be a short-term strategy for increasing off-take and lowering stocks. In the long run, there is a need to boost export competitiveness, through both price and non-price factors, to overcome the problem of growing stocks.

The supply response of Indian agriculture, though predominantly determined by monsoon, has also been significantly influenced by structural bottlenecks such as inadequate infrastructure, particularly in irrigation. Furthermore, the successive increases in MSPs of rice and wheat in contrast to declining world prices has led to reduced export competitiveness of Indian rice and wheat. The rising MSPs of rice and wheat also favoured their increased cultivation, leading to higher procurement. As opposed to growing procurement, the off-take has been low due to increasing CIPs on one hand and the changes in consumption pattern away from cereals to non-traditional food items on the other. Thus, the increasing procurement and low off-take resulted in mounting foodgrain stocks, which have had monetary and fiscal implications, particularly in terms of the unprecedented growth in food subsidy. The growth in food subsidy has serious opportunity costs, especially in terms of investment in irrigation and other infrastructure, which in turn would have facilitated higher agricultural growth.

Irrespective of the fiscal costs that are imposed by the increasing MSPs by way of aiding increased procurement, it is worthwhile to reiterate that it serves the role of price stabilisation. The policy intervention to support agriculture is less in India, than in many OECD countries. If the level of subsidies accorded to these commodities is reduced in USA and European countries, Indian cereal production would retain competitiveness. It can be said that the Indian price policy has provided a modicum of income protection to farmers, albeit with fiscal costs

It is interesting to note that the recent predicament of mounting foodstocks occurred despite a deceleration in agricultural growth. It is quite possible that the foodgrain stock piling could have been much more, had there been higher growth in rice and wheat production. The increasing production of rice and wheat, in conjunction with the increasing MSPs would have resulted in much higher procurement, mainly due to inadequate market clearance caused by the declining demand for cereals. This would have led to larger levels of stocks and hence, higher economic costs.