Has RBI Lost Control of Monetary Policy?

On August 31, 2020, the Reserve Bank of India (RBI), published an innocuously titled press release RBI Announces Measures to Foster Orderly Market Conditions. The third paragraph and the fourth line of the release said this: “The recent appreciation of the rupee is working towards containing imported inflationary pressures [emphasis added].”

What did this line mean? Take a look at the following chart. As of June 18, one dollar was worth Rs 76.55. By August 31, one dollar was worth Rs 73.13. The rupee had gained value or appreciated against the dollar.


Rupee Up, Dollar Down

 
Source: Yahoo Finance.

What has this got to do with inflation? When the value of the rupee appreciates against the dollar, the imports become cheaper.

Let’s say the price of a product being imported into India is $10. If the dollar is worth Rs 76, it costs Rs 760. If the dollar is worth Rs 73, it costs Rs 730. Hence, if the rupee appreciates, imports become cheaper and in the process the inflation (or the rate of price rise) that we import from abroad, comes down as well.

The trouble is that if imports become cheaper, things become difficult for the home-grown products. Hence, an appreciating rupee goes against the government’s pet idea of atmanirbhartha or producing goods locally.

Given that the current dispensation at the RBI is more or less in line with what the government wants, this move to allow the rupee to appreciate, so that it reduces imported inflation, is even more surprising. (On a different note, I am all for consumers getting to buy things cheaper than in the past. The point of all economic activity, at the end of the day, is consumption. But most people don’t think like that).

Also, RBI’s Monetary Policy Report released in April, suggests that the impact of the appreciation of rupee on inflation is at best marginal: “An appreciation of the Indian Rupee by 5 per cent could moderate inflation by around 20 basis points.” One basis point is one hundredth of a percentage.

The trilemma

So what’s happening here? The RBI has basically hit the trilemma, something which it can’t admit to. Trilemma is a concept which was originally expounded by the Canadian economist Robert Mundell. Basically, a central bank cannot have free international movement of capital, a fixed exchange rate and an independent monetary policy, all at the same time. It can only choose two out of these three objectives. Monetary policy refers to the process of setting of interest rates in an economy, carried out by the central bank of the country.

Of course, this is economic theory and in practice things are slightly different. The more a central bank allows free international movement of capital (i.e. money) and has a tendency to continuously intervene in the foreign exchange market and not allow free movement in the price of the local currency against the dollar, the lesser control it has over its monetary policy.

Let’s try and understand this through an example. Let’s consider the central bank of a country which allows for a reasonable movement of capital. At the same time, it wants to ensure that the value of its currency against the US dollar doesn’t move much.

This is to ensure that its exporters don’t face much volatility on the exchange rate front. Over and above this, the central bank does not want its currency to appreciate because that would hurt the exporters and make them less competitive.

In this scenario, let’s say the central bank sets interest rates at a higher rate than the rates in the United States and other parts of the world. What will happen is given that reasonably free movement of capital is allowed money from other parts of the world will come flooding in to cash in on the higher interest.

When the foreign capital comes into the country in the form of dollars and other currencies, it will have to be converted into the local currency. This will lead to the demand of the local currency going up and the local currency will appreciate against the dollar. Of course, when this happens, the value of the local currency will no longer remain fixed against the US dollar.

This is where the trilemma comes to the fore. If the country wants monetary independence and free movement of capital, it cannot have a fixed exchange rate. If it wants a fixed exchange rate then it has to set interest rates around the interest rate set by the Federal Reserve, so that it doesn’t attract capital because of a higher interest rate. In the process, it loses control of monetary policy.

In the Indian case, in the recent past, the RBI has tried to pursue all the three objectives, reasonably free movement of capital, a currency (the rupee) which doesn’t appreciate against the dollar and an independent monetary policy.

The repo rate, or the rate at which the RBI lends to banks, was cut from 5.15% to 4%, in the aftermath of the covid-pandemic. The RBI has also flooded the financial system with money by buying government bonds.

Between February 24 and April 23, the RBI lent a lot of money to banks through long-term repo operations, targeted long-term repo operations and targeted long-term repo operations 2.0. These schemes have essentially lent money to banks at the repo rate for the long term. On February 24, the RBI lent Rs 25,021 crore to banks for a period of 365 days at the prevailing repo rate of 5.15%. The repo rate is the interest at which RBI lends to banks, typically for the short-term.

After this, the RBI has lent around Rs 2.13 lakh crore for a period of around three years at the prevailing repo rate. Around Rs 1 lakh crore out of this was lent at 5.15%. In late March, the RBI cut the repo rate by 75 basis points to 4.4%. The remaining Rs 1.13 lakh crore has been lent at this rate. The idea here was to encourage to lend money to banks at a low interest rate and then encourage them to lend further, under certain conditions. There has been more bond buying over and above this.

The idea was to drive down interest rates to lower levels, so that companies borrow and expand, people borrow and consume. In the process, the economy starts to recover. Also, with the government borrowing more this year, lower interest rates would help it as well.

Along with this, the reasonably free movement of capital that India allows has continued. The RBI has also intervened in the currency markets trying to ensure that the rupee doesn’t appreciate against the dollar.

What’s happening here? In the aftermath of covid, Western central banks have gone on a money printing spree, some to drive down interest rates and to get businesses to expand and people to consume, and some others to finance the expenditure of their government. Take the case of the Federal Reserve of the United States. Between February end and early June, it printed a close to $3 trillion and expanded its balance sheet by three-fourths in the process.

To cut a long story short, interest rates have been driven down globally and there is a lot of money going around looking for some extra return. Some of this money has been coming to the Indian stock market.

In 2020-21, the current financial year, the foreign institutional investors (FIIs) have net invested $7.62 billion in the Indian stock and bond market. A good amount of this, $6.66 billion, came in August, when FII investment turned into a deluge. Of course, there were months like April and May, when the FIIs net sold. Between June and August, the FIIs net invested $10.54 billion in the Indian stock and bond markets.

The foreign direct investment (FDI) coming into India between April and July stood at $5.86 billion, with $4.01 billion coming just in July. The outward FDI (Indians investing abroad) in the first four months, stood at $3.17 billion. This means that the net FDI number (foreign investments made by Indians deducted from investments in India by foreigners) has been in positive territory. Net-net dollars have come into India on the FDI front.

Over and above this, the net receipts from services (i.e. services exports minus services imports) stood at around $28 billion between April and July.

Other than this, the demand for dollars, from within India, has come down. The import of crude oil and petroleum products between April and August 2020 has fallen by 53.7% to $26.02 billion. This has been both on account of fall in price of oil as well as lower consumption. In fact, on the whole, the goods exports have fallen at a lesser pace than goods imports, again implying a reduced demand for dollars within India.

Internal remittances, the money sent by Indians working abroad back to India, must have definitely fallen this year (I say must because the data for this isn’t currently available). Nevertheless, at the same time, outward remittances, everything from money spent on health, education and travel, has also come down, given that barely anyone is travelling abroad.

What does this basically mean? It means more dollars are coming into India than leaving India. When dollars come into India they need to be converted into rupees. This increases the demand for rupees and the rupee then appreciates against the dollar. This, as I have explained above, hurts atmanirbharta, domestic producers of goods and exporters, all at once.

Preventing the appreciation of the rupee

To prevent the rupee from appreciating against the dollar, the RBI buys dollars by selling rupees. In fact, that is precisely what the RBI has done between April and July this year. It has net purchased $29 billion, the highest in this period in the last five years. The August press release suggests that the RBI stopped trying to defend the rupee from appreciating sometime during the month or at least didn’t try as hard as it did in the past.

If we look at the foreign currency assets of the RBI they have barely moved between August 28 (three days before the press release) and September 18 (the latest data available), barely increasing from $498.36 billion to $501.46 billion. This tells us that the RBI isn’t really intervening much in the foreign exchange market in the recent past. But that might also be because of the fact that in September (up to September 29), the FIIs have net sold stocks and bonds worth just $4 million. Net net, FIIs didn’t bring any dollars into India in September.

By buying dollars, the RBI releases rupees into the Indian financial system and thus increases the money supply. In the normal scheme of things, the RBI can sterilise this by selling bonds and sucking out this money. But that would have gone against the easy money policy that the Indian central bank has been running through this financial year.

The excess liquidity (or the money that the banks deposit with the RBI) in the financial system suggests that the RBI hasn’t really been sterilising the rupees it has put into the system to prevent the appreciation of the rupee. On the whole, the bond buying by the RBI in order to release money into the financial system, has been in the positive territory. The following chart plots this excess liquidity in the system.

Easy Money


Source: Centre for Monitoring Indian Economy.

 

The excess liquidity in the system, money which banks had no use for and parked with the RBI, even crossed Rs 6 lakh crore in early May. It has since fallen but is still at a very high Rs 2.72 lakh crore.

So, what does all this mean?

The inflation between April and August, as measured by the consumer price index, has been at 6.63%. The inflation in August was at 6.69%. As per the RBI’s agreement with the government the inflation should be 4% within a band of +/- 2%.

This means that the current inflation is way beyond range. A major reason for this is high food inflation which between April and August has been at 9.58%. The food inflation in August was at 9.05%.

If we look at the core inflation (which leaves out food, fuel and light), it is at 5.16%. If we add fuel inflation to this (thanks to the government increasing the excise duty on petrol and diesel), the inflation is higher.

Where does this leave the RBI? All the liquidity in the financial system hasn’t led to even higher inflation primarily because there has been an economic collapse and people are not spending money as fast as they were in the past.

Food inflation has primarily been on account of supply chains breaking down thanks to the spread of the covid-pandemic. The trouble is that covid is now spreading across rural India. As Crisil Research put it in a recent report: “Of all the districts with 1,000+ cases, almost half were rural as on August 31, up from 20% in June.” This basically means that the supply chain issues when it comes to movement of food are likely to stay, during the second half of the year as well.

Food on its own makes up for 39.06% of the overall index and 47.25% of the index in rural India. As the Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (better known as the Urjit Patel Committee) said:

“High inflation in food and energy items is generally reflected in elevated inflation expectations. With a lag, this gets manifested in the inflation of other items, particularly services. Shocks to food inflation and fuel inflation also have a much larger and more persistent impact on inflation expectations than shocks to non-food non-fuel inflation.”

An IMF Working Paper titled Food Inflation in India: The Role for Monetary Policy suggests the same thing: “Food inflation [feeds] quickly into wages and core inflation.” This is something that the country saw in the five-year period before 2014, when food inflation seeped into overall inflation.

What this means is that if covid continues to spread through rural India and food supply chains continue to remain broken, food inflation will persist and this will seep through into overall inflation, which is anyway on the high side.

In this situation what will the RBI do in the months to come? As mentioned earlier, all the money that the RBI has pumped into the Indian financial system hasn’t led to an even higher inflation simply because the consumer demand has collapsed. But as the economy continues to open up and the demand picks up, there is bound to be some amount of excess money chasing the same amount of goods and services, leading to higher inflation.

In this scenario what will the RBI do to prevent the appreciation of the rupee against the dollar, especially if foreign capital continues to come to India and the demand for the rupee continues to remain high?

As mentioned earlier, if the RBI buys dollars and sells rupees to prevent appreciation, it will continue to add to money supply. Interestingly, the money supply (as measured by M3 or broad money) has been growing at a pace greater than 12% (year on year) since June. This kind of rise in money supply was previously seen only before 2014, a high inflation era.

If RBI keeps trying to intervene in the foreign exchange market to prevent the appreciation of the rupee against the dollar, it will keep adding to the money supply and that creates the risk of even higher inflation. To counter this risk of higher inflation, the RBI will need to raise the repo rate or the interest rate at which it lends to banks.

This goes against what the Indian economy or for that matter any economy, needs, when it is going through an economic contraction. This in a way suggests that the RBI has lost control over the monetary policy. In fact, even if the monetary policy committee (MPC) of the RBI, whenever it meets next, keeps the repo rate constant, it suggests a lack of control over monetary policy. This also explains why the RBI hasn’t made any inflation projections since February this year.

Of course, the RBI has the option of sterilising the extra rupees it releases into the financial system by buying dollars coming into India. In order to sterilise the extra rupees being released into the financial system, the RBI needs to sell government bonds. The RBI needs to pay a certain rate of interest on these bonds. These bonds are a liability for the RBI.

As far as assets of the RBI go, a significant portion is invested in bonds issued by the American and other Western governments and the International Monetary Fund. These assets pay a much lower rate of interest than the interest that the RBI needs to pay on bonds it sells to sterilise excess rupees in the financial system. This is referred to as the quasi fiscal cost and needs to be kept in mind.

The second problem with sterilisation is that it might lead to a situation where interest rates might go up, creating further problems. As an RBI research paper titled Forex Market Operations and Liquidity Management published in August 2018 points out:

“For example, when a central bank undertakes open market sale of government securities to absorb the surplus liquidity as a part of the sterilised intervention strategy, it could harden sovereign yields, which, in turn, could attract further debt inflows driven by higher interest rate differentials.”

What does this mean in simple English? When the RBI sells government bonds to carry out sterilisation, it sucks out excess rupees from the market. This might lead to interest rates going up. If interest rates go up more foreign money will come into India looking to earn that higher interest rate. And this will create the same problem all over again, with the demand for rupee going up and the RBI having to intervene in the foreign exchange market.

Any increase in interest rates will not go down well with the government which will end up borrowing a lot of money this year, thanks to a collapse in tax revenues. Take a look at the following chart which plots the 10-year government bond yield from the beginning of 2020. The 10-year government bond-yield is the return an investor can expect per year, if they continue owning the bond until maturity.

Down and then slightly up

Source: https://in.investing.com/rates-bonds/india-10-year-bond-yield-historical-data

Thanks to all the easy money created by the RBI there has been excess money in the Indian financial system, since the beginning of this year. This has helped drive down bond yields from around 6.5% at the beginning of the year to a low of 5.76% in July and to around 6.04% currently. Hence, the Indian government has been able to borrow at a lower rate thanks to the excess liquidity created by the RBI and it wouldn’t want that to change. Also, the yields have been rising gradually since July, making sterilising even more difficult.

If the RBI keeps intervening it creates the risk of increasing money supply and that leading to the risk of even higher inflation. A high inflation in a poor country is never a good idea. If the RBI does not intervene that leads to the rupee appreciating and in the process creating problems for the domestic industry as well as the atmabnirbhar strategy. The exporters suffer as well.

What’s the RBI’s best strategy here? It can pray that foreign inflows slow down for a while, like they have in September. But that was basically the FIIs reacting to the Indian economy contracting by nearly a fourth between April to June. This data point was published on August 31. Also, as the economy keeps opening up more and more, imports and other spending pick up, the demand for the dollar will go up as well. All this will help the RBI. Nevertheless, if Western central banks unleash even more money printing, then all this will go for a toss.

The RBI ended up in this position by abandoning its main goal of managing price inflation. The agreement between the government and the RBI states clearly that “the objective of monetary policy is to primarily maintain price stability [emphasis added], while keeping in mind the objective of growth.”

Instead of managing inflation, the RBI chose its role as the debt manager of the government to outshine everything. This led to all the excess liquidity in the system so that interest rates were driven down and the government could borrow at lower interest rates. The Times of India reports on October 1, 2020: “The weighted cost of borrowing [for the government] during the first half was 5.8%, the lowest in 15 years.”

While the government has borrowed more, the overall non-food credit given by banks has shrunk between March 27 and September 11, from Rs 103.2 lakh crore to Rs 101.6 lakh crore. The banks lend money to the Food Corporation of India and other state procurement agencies to primarily buy rice and wheat (and some oilseeds and pulses in the recent past) directly from the farmers. Once this credit is subtracted from overall credit of banks what remains is non-food credit.

What this tells us is that despite lower interest rates overall lending by banks has shrunk. This might primarily be because of people and firms prepaying loans as well as a general slowdown in loan disbursal. Of course, the fall in interest rates has hurt savers and nobody seems to be talking about them.

To conclude, the RBI abandoned its main goal and is now stuck because of that. As economists Raghuram Rajan and Eswar Prasad wrote in a 2008 article : “The central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”

By trying to do too many things at the same time, RBI ends up being neither here nor there. As Rajan and Prasad put it: “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well.” This was a mistake the RBI used to make pre-2015, before the agreement with the government was signed. It has gone back to making the same mistake again.

As Rajan wrote in the 2008 Report of the Committee on Financial Sector Reforms“The Reserve Bank of India (RBI) can best serve the cause of growth by focusing on controlling inflation.”

But that’s not to be, given that politicians, bureaucrats and even economists, expect monetary policy to perform miracles it really can’t.

I would like to thank Chintan Patel for research assistance. 

 

How to Run Public Sector Banks Well Without Privatising Them. And Why That’s Not Going to Happen

As of March 31, 2020, the total bad loans of public sector banks stood at Rs 6,78,318 crore. This is a drop of 24.3% from a peak of Rs 8,95,600 crore as of March 2018. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.

So how did bad loans of public sector banks come down by nearly a fourth? First and foremost, as of March 31, 2018, IDBI Bank, the worst performing bank when it comes to bad loans, was a public sector bank. From January 21, 2019, the bank was categorised to be a private bank. Accordingly, its bad loans moved to the overall bad loans of private banks. But we need to remember IDBI Bank is owned by the Life Insurance Corporation of India, that makes it as close to being a private bank, as Indian Chinese food is close to the real Chinese food.

As of March 31, 2020, the overall bad loans of IDBI Bank were Rs 47,272 crore. If we add this to the bad loans of public sector banks, the real bad loans of public sector banks work out to Rs 7,25,590 crore (Rs 6,78,318 crore + Rs 47,272 crore). This means that the real fall in bad loans of public sector banks in the two-year period has been around 19% and not 24.3%, as we originally calculated.

So, bad loans worth Rs 47,272 crore came down, simply because IDBI Bank got recategorised as a private bank.

Let’s move to the next point. Take a look at the following chart, which basically plots the bad loans of public sector banks over the years. The bad loans of IDBI Bank are included in this chart.

India’s Manhattan

Source: Centre for Monitoring Indian Economy and Indian Banks’ Association.

As I elaborate in detail in my book Bad Money, the RBI practiced regulatory forbearance between 2011 and 2014 and did not force public sector banks to recognise their bad loans as bad loans, even though they had started to appear by then. In simple English, regulatory forbearance, essentially means the central bank looking the other way from the problem.

An asset quality review (AQR) was launched in mid 2015 and this forced banks to recognise their bad loans as bad loans. As you can see in the chart, the overall bad loans of public sector banks take a huge jump post 2014-15. This was the AQR at work.

Now loans which have been bad loans for four years can be dropped from the balance sheet of banks by way of a write-off. Hence, many loans which had been categorised as bad loans in 2015-16 would have spent four years on the balance sheet by 2019-20.

Accordingly, they got written off from the balance sheet of banks. Of course, before such bad loans are written off, a 100 per cent provision needs to be made for these bad loans. This means that banks need to set aside money to meet the losses arising from these loans. This essentially led to the overall bad loans of banks coming down as well.

And over and above this, the banks would have managed to recover a portion of the bad loans (which includes bad loans that have been written off as well). The overall recovery rate for banks through various recovery channels during 2018-19 was around 15.5% of the amounts involved. (Numbers for 2019-20 aren’t currently available or at least I couldn’t find them anywhere).

In fact, a bulk of the current accumulated bad loans will disappear from the balance sheets of public sector banks over the next two to three years, thanks to the fact that bad loans can be written off after they have spent four years on the balance sheet.

Nevertheless, the question is: even after this can the public sector banks operate in a healthy way where they don’t need to be constantly recapitalised. In fact, once public sector banks get around to identifying post-covid bad loans early next year, their balance sheets are likely to come under stress again.

But the basic problem of public sector banks remains interference by the government. This interference can take several forms. As Viral Acharya and Raghuram Rajan write in a research paper titled Indian Banks: A Time to Reform?: “Interference, including appointing favoured candidates to management, expanding lending just before elections, or directing banks to lend to favoured borrowers is obviously harmful.” (Again, something I discuss in great detail in my book Bad Money).

To ensure that public sector banks do not face this kind of interference it has been suggested that they need to be privatised. Over and above this, there have been news reports which suggest that the government is looking to privatise public sector banks.

This remains a difficult decision politically. Also, in an economic environment like the one prevailing, there will be fairly limited number of firms looking to buy government banks saddled with a huge amount of bad loans and a section of employees not used to the idea of working.

Further, unlike other public sector enterprises, the government has to be even more careful while selling a bank. As Acharya and Rajan write:

“The experience in other countries with allowing corporations to own banks is that it increases the possibility of self-dealing within the group – the bank is used to make risky loans to failing group entities, and the bill is paid by the tax payer when the bank is eventually bailed out.”

They further say that the Indian industry is already heavily concentrated. As a recent McKinsey Knowledge Centre report titled India’s turning point An economic agenda to spur growth and jobs points out: “Our analysis shows that just 20 of the country’s roughly 600 large firms contribute 80 percent of the total profit of large firms.” The report defines large firms as firms with an annual revenue of more than $500 million.

If India’s large corporates end up buying its banks, the industry is likely to get even more concentrated. Hence, while privatisation of public sector banks remains a good idea over a long-term, currently, the government can initiate the reform process through the Axis Bank model, wherein the government is an investor in banks rather being a promoter.

The Committee to Review Governance of Boards of Banks in India (better known as the Nayak Committee, after its chairman, PJ Nayak) which presented its report to the RBI in May 2014, suggested the Axis Bank model.

Axis Bank was originally called UTI Bank. It was set up in 1993. It was owned by the Unit Trust of India (UTI) and a clutch of public sector banks. Even though ownership was 100 per cent in the public sector, the bank got a licence to operate as a private sector bank. The bank was listed on the stock exchanges in 1998. UTI Bank was later renamed Axis Bank.

Even at that point of time, the public sector shareholding continued to be the majority shareholding. In early 2000s, when the Unit Trust of India ran into trouble, the government broke it down into two parts. One part became the UTI Mutual Fund and the other was the Specified Undertaking of the Unit Trust of India (SUUTI).

In February 2003, the shareholding of UTI in the bank was transferred to SUUTI. UTI Bank was later renamed Axis Bank.

As the Nayak Committee Report pointed out:

“The Government-as-Investor stance has characterised the control of the Bank, with SUUTI acting as a special purpose vehicle holding the investment on behalf of the Government. The CEO is appointed by the bank’s board, and because the bank was licensed in the private sector, it sets its own employee compensation, ensures its own vigilance enforcement (rather than being under the jurisdiction of the Central Vigilance Commission), and is not subject to the Right to Information Act. SUUTI appoints the non-executive Chairman and up to two directors on the Board, and there is no direct intervention by the Finance Ministry.”

This means that the bank has been run as a proper banking business, without much intervention from the government. Between March 2003 and March 2014, the share price of Axis Bank rose thirty-two times. Over the years, the government has been able to sell its stake in the bank to raise a decent amount of money.

The point being that even though, as per its shareholding, Axis Bank ‘was for many years a public sector bank’, but ‘fortuitously, the bank was licensed at the commencement of its business as a private sector bank’.

The Nayak Committee Report suggests that the government should look at public sector banks as an investment and not as a business it has to run, and follow the Axis Bank model. This essentially means the government reducing the stake in these banks to less than 50 per cent, and letting the bank’s management and its board do their job, like in the case with private sector banks.

But then as the oft-repeated cliche goes, public sector banks are not just about making money. They also need to keep the social objectives of the government in mind. This is something that even Prime Minister Narendra Modi had suggested at the First Gyan Sangam in 2015 (a meeting of bureaucrats, bankers and insurers). As Modi had said on that occasion, while “government interference was inappropriate, but government intervention was needed to further public objectives”.

It’s this line of thought has driven India’s public sector enterprises for seven decades now and gotten them nowhere in the process.

R C Bhargava, the current Chairman of Maruti Suzuki, who was also an IAS officer for a very long time, writes the following in his book Getting Competitive: A Practitioner’s Guide for India:

“The USSR was the pioneer in attempting industrialization along with creating a communist society. It did not succeed. On the other hand, Japan became a highly competitive and industrialized nation and has a high degree of equality and social justice. The policies for regulating and promoting industrial growth do not have any social content in them [emphasis added]. Social equality was a result of the political and industrial leadership understanding that manufacturing competitiveness would be enhanced if there was greater equality and the bulk of the people were enabled to become consumers of manufactured goods.”

What Bhargava, who has worked for long periods of time, both for the government and the private sector, is basically saying is that social objectives of the government shouldn’t become objectives of its enterprises.

This does not mean that the government should do away with meeting its social objectives. Not at all. But what it should do instead is incentivise banks on this front.

As Acharya and Rajan write:

“Perhaps a better approach would be to pay for the mandates (such as reimbursing costs for maintaining branches in remote areas or opening bank accounts for all) so that both private banks and public sector banks compete to deliver on them. This will distance the public sector banks a little from the government. While public sector banks may be given a slightly different set of objectives than private banks (for example, they may put more weight on financial inclusion), their boards should have operational independence on how to achieve the objectives.”

Competition and incentivisation goes a much longer way in delivering services than a government diktat.

The question is, where will the money for all this come from? Allow me to throw a few numbers at you, before I answer this question.

The market capitalisation of the State Bank of India, India’s biggest bank and the biggest public sector bank, is Rs 1.67 lakh crore. The total assets of the bank as of March 2020 were at Rs 41.97 lakh crore. Now compare this to Kotak Mahindra Bank. Its market capitalisation is at Rs 2.53 lakh crore. The total assets of the bank as of March 2020 stood at Rs 4.43 lakh crore.

Hence, in comparison to the State Bank of India, the Kotak Mahindra Bank is a very small bank. But its market capitalisation is almost Rs 86,000 crore more. Why? Simply because Kotak Mahindra Bank is run like a proper bank and the stock market gives it a proper valuation for the same.

Or take the case of HDFC Bank, which has a market capitalisation of Rs 5.80 lakh crore, which is more than all public sector banks put together. Both these well-run banks have much lower bad loans than public sector banks. The overall bad loans of private banks, Yes Bank notwithstanding, are significantly lower than public sector banks even after adjusting for their size.

The point I am trying to make here is that if public sector banks end up being much better run than they currently are, the stock market will give them a higher market capitalisation. And the government can then finance its social objectives by gradually selling the shares it owns in these banks.

Of course for anything like that to happen, the Department of Financial Services in the Finance Ministry which controls the public sector banks, needs to take a backseat. As Rajan writes in I Do What I Do: “Unless PSBs are run like normal corporations, they will not be competitive in the medium term. I have a simple metric of progress here: We will have moved significantly towards limiting interference in PSBs when the Department of Financial Services (which oversees public sector financial firms) is finally closed down, and its banking functions taken over by bank boards.”

But as we all know, bureaucrats don’t take backseats.

Oh and politicians. Let’s not forget them here. Back in 2000, the Atal Bihari Vajpayee government tried to push through the move and dilute the government stake in PSBs to 33 per cent. And it failed. Why?

Vajpayee’s finance minister, Yashwant Sinha, had introduced a bill to reduce the government’s stake in PSBs to 33 per cent. It never saw the light of day. In a 2018 interview, Sinha said: “The parliament and the people were not prepared for such [a] kind of step”.

In fact, all these years down the line, we are still grappling with the same issue.

The more things change…

And I sincerely hope, I am proven wrong on this.

Propaganda 101: What the Indian Right has learnt from Big Tobacco

The Indian economy as measured by the gross domestic product (GDP) contracted by 23.9% during April to June 2020 in comparison to the same period in 2019. This contraction was huge.

But soon journalists, economists, corporate honchos and analysts, who are close to the current dispensation, started telling us that, so what if India has contracted by 23.9%, the American economy contracted by 32% during the same period. The point being that if India was in trouble, America was in bigger trouble. How did this lessen our trouble they didn’t bother to explain.

There was an even bigger problem with the 32% American contraction figure. It was wrong, when compared to India’s 23.9% contraction. The way India calculates GDP contraction (or growth for that matter) and the way America does it, are different.

So, what was the American contraction if we used the Indian method? It was 9.1% year on year and not 32% as was being suggested. (For those interested in the fifth- standard maths behind this, I suggest you Google it. It has been explained by multiple people, including me).

Also, none of the people who sincerely believed that the American economy had contracted by 32%, bothered to sit back and think the negative impact this would have had on the world at large.

Data from the World Bank suggests that in 2019, the American GDP (real GDP adjusted for inflation), had stood at $18.3 trillion.
This was around 21.7% or somewhere between a fourth and a fifth of the global GDP. Now imagine the American economy contracting by a third (which is what a 32% contraction almost means) year on year. This would have led the world into a second Great Depression.

America is the world’s largest source of consumer demand. If that demand contracts by a third, the global economy would have been in an even worse situation than it currently is. This simple thought did not occur to anyone who went around town telling people that the American economy had contracted by 32% and hence, had done much worse than the Indian economy. Or maybe it did occur to them, and they simply chose to ignore it.

The Indian GDP numbers for April to June were declared on August 31. This was almost four weeks back. The social media is still buzzing with this issue.

Do the people who spread the story of the US economy contracting by 32% to counter the Indian economy’s contraction of 23.9%, not understand basic fifth standard maths? Because a simple understanding of fifth standard maths would have told them very clearly that the US economy had contracted by 9.1%, if the contraction is calculated in the Indian way.

Obviously, this bunch of people is a smart lot and I don’t think there is any problem with their understanding of fifth standard maths. So, what were they up to then? They were basically borrowing a simple idea first used by Big Tobacco Companies in the 1950s.

In the early 1950s, research which linked the smoking of cigarettes to incidence of lung cancer, started to come out. Big Tobacco Companies met at the Plaza Hotel in New York, just before Christmas in 1953. Scientific research which was being published was making them look very bad. And they had to do something about it.

What did they do? As Tim Harford writes in How to Make the World Add Up: Ten Rules for Thinking Differently About Numbers: “They muddied the waters. They questioned the existing research; they called for more research; they funded research into other things they might persuade the media to get excited about, such as sick building syndrome or mad cow disease. They manufactured doubt. A secret industry memo later reminded insiders that ‘doubt is our product’.”

How did muddying the waters help Big Tobacco? It basically created confusion in the minds of smokers. Was the research linking smoking to lung cancer, right? Was there enough evidence of it? Aren’t correlation and causation two different things? These were the questions that the smokers were suddenly asking themselves.

As Harford writes: “Smokers liked smoking, were physically dependent on nicotine, and wanted to keep smoking if they could. A situation where smokers shrugged and said to themselves. ‘I can’t figure out all these confusing claims’ was a situation that suited the tobacco industry well.”

Big tobacco wasn’t trying to tell smokers that smoking was safe. They weren’t so blatant about it. All they were trying to do was to ‘create doubt about the statistical evidence that showed they were dangerous’.

The muddying of waters to create doubt has been a standard part of propaganda since then. It’s propaganda 101. As Harford summarises it: “Their answer [that of Big Tobacco companies] was – alas – quite brilliant, and set the standard for propaganda ever since.”

Something very similar happened in case of the Indian economy contracting by 23.9%, as well. The fact that the Indian economy contracted by close to a fourth, was something that the sympathisers couldn’t deny. It was official government data. And of course, that this contraction was bad for the average Indian, couldn’t be denied either.

But the waters could be muddied by getting the American angle in. The message was that so what if the Indian economy has contracted and Indians are suffering, the Americans are suffering more.

The sad part of all this is that many educated Indians fells for this spin. But that’s the thing with propaganda, even the educated fall for it.

This piece originally appeared in the Deccan Herald on September 27, 2020. 

Are Acche Din Here for Onion Farmers and Consumers?

Yesterday (September 22, 2020), the Rajya Sabha passed the Essential Commodities (Amendment) Bill, 2020. The Lok Sabha had passed the Bill a week back on September 15. The passage of this Bill essentially dropped cereals, pulses, oilseeds, edible oils, potatoes and onions, from the definition of essential commodities.

The government may regulate the supply of food items only under extraordinary circumstances like war, famine, extraordinary price rise and a natural calamity of grave nature.

In this piece we will concentrate on what this change means in the context of onions.

India grows 10% of the world’s onions. It is the second largest producer of onions in the world, after China. In 2019-20, the total onion production across the country stood at 251.46 lakh tonnes. But despite being the second largest producer in the world, the price fluctuations of onions within the country are huge.

In fact, on more than a few occasions in the past, the price of onions has crossed Rs 100 per kg, causing a lot of pain across households, with the onion being an important ingredient in different kinds of food all across the country. Elections have been lost on the price of onions going up, making it a politically sensitive vegetable.

Take a look at the following chart, which basically plots the inflation of onions as measured by the consumer price index. Inflation is the rate of price rise.

Up and Down


Source: Centre for Monitoring Indian Economy.

(The curve is broken towards the end because data for a couple of months wasn’t available due to the covid-pandemic).

The inflation of onions is all over the place. It just tells us how volatile onion prices are at the consumer level. It’s not just the consumers who face this volatility, even the farmers face volatility in the price they get for the onions that they grow.

All over the place

Source: Centre for Monitoring Indian Economy.

The above chart shows the volatility of onion prices at the wholesale level. And the way the curve goes up and down, tells us that onion prices move around quite a lot, even at the wholesale level.

What does this mean for the consumer and the farmer? The onion consumer doesn’t get to buy onions at a consistent price, the prices go up and down, quite a lot. On the other hand, the onion farmer doesn’t get to sell onions at a consistent price. There is always a chance that when the farmer goes out to sell the onions he has grown, there is a price crash. In that sense, growing onions for a living becomes a very risky profession.

The question is why are onion prices so volatile? This is where things get interesting. Take a look at the following chart (I know, I am throwing a lot charts at you, dear reader, but these are simple straightforward charts.) The chart plots the wholesale prices of onions through the months, over the years.

Rise in wholesale onion prices

Source: http://ficci.in/spdocument/23156/FICCI’s-paper-on-Onion-Crisis.pdf

What does the chart tell us? It tells us that the wholesale onion price start rising around May and they keep rising till around August-September. This is where the entire problem lies, both for consumers as well as farmers.

Why is that the case? The onion has three harvesting seasons; the Rabi season (March-May), the Kharif season (October-December) and late Kharif season (January-March). Close to 60% of the onion production happens during the Rabi season.

Also, the onions produced during the Rabi season are most amenable to storage. The supply of fresh onions hitting the market between May to September is simply not enough to meet the demand. Given this, a part of demand has to be met through stocks of Rabi onions maintained by traders and wholesalers.

When the supply from the Rabi season starts to run out, the price of onions tends to rise. If there are any rains it makes the situation worse. The rains not only destroy the early Kharif crop which starts hitting the market in late September-early October, but they also destroy the Rabi crop that has been stored.

In fact, this is precisely what has happened in 2019 as well as 2020. As the Economic Survey for 2019-20 points out: “Due to heavy rains in August-September, 2019, the kharif crop of onions was adversely affected leading to lower market arrivals and upward pressure on onion prices. This kharif crop usually caters to the demand during the period from October to December till fresh produce from late kharif crop comes in the market.” Something similar has happened this year as well, with rains destroying the onion crop in Karnataka.

Hence, as an economist would put it, there is a structural problem at the heart of the onion trade in India. The government notices this only when there is a price rise and the media starts splashing it. Hence, there is always a knee-jerk reaction.

The government has a fixed way of reacting. It either invokes the Essential Commodities Act (ECA), 1955, or bans exports of onions (and if not that, it makes exports unviable by increasing the minimum export price).

Last year, on September 29, stocks limits under the ECA were imposed. Retail traders could stock up to 100 quintals of onions and wholesale traders could stock up to 500 quintals. (One quintal = 100 kgs. This was later reduced to 20 quintals and 250 quintals, respectively).

The idea here being that as soon as stock limits are imposed anyone who has onions stocked beyond the limit will have to sell them in the open market and that will push down wholesale prices and in the process retail prices (at least, that is what the government hopes).

This year on September 14, onion exports were banned under the Section 3 of the Foreign Trade (Development and Regulation) Act, 1992. The trigger was the more than doubling in the average price of onion arriving at India’s biggest onion market at Lasalgaon near Nashik, between end of March and September 14.

The modal price of onion as of March 30 was Rs 1,301 per quintal. By September 14, the modal price had jumped to Rs 2,801 per quintal. After the export ban on September 14, on September 15 the wholesale onion prices crashed to Rs 1,901 per quintal. Obviously, this did not go down well with the onion farmers.

The third option that the government resorts to is the import onions. This does not bring immediate consumer relief because imports carried out through government institutions take time. Even after onions have been imported, there is trouble is storing, distributing and selling them, because government institutions involved in this process, really don’t have the expertise for it. Also, in the past, the taste of imported onions hasn’t really gone down well with the Indian consumers.

So, what’s the way out of this mess? Let’s take a look at this pointwise.

1) The ECA is a remanent of an era when India had genuine food shortage. The idea was to restrict activities of some agents who were indulging in black marketing and hoarding at that point of time.

As a July 2018 report titled Review of Agricultural Policies in India published by the Organisation for Economic Co-operation and Development, points out: “Orders issued by the centre or the states regulate the production, storage, transport, distribution, disposal, acquisition, use or consumption of a commodity.”

While, we do have our share of problems with some food products where the price volatility is very high (pulses and onions in particular), the days of food shortage are long gone. Also, over the years, the fact that ECA exists has undermined investments in India’s agricultural supply chain infrastructure.

As the Economic Survey of 2019-20 points out:

“ECA interferes with this mechanism by disincentivising investments in warehousing and storage facilities due to frequent and unpredictable imposition of stock limits. As stockholding limits apply to the entire agriculture supply chain, including wholesalers, food processing industries and retail food chains, the Act does not distinguish between firms that genuinely need to hold stocks owing to the nature of their operations, and firms that might speculatively hoard stocks.”

This fear of stock holding limits essentially leads to entrepreneurs staying away from creating supply chain infrastructure.

2) The lack of storage facilities adds to the price volatility of onions. As per a report titled A Report on the study of Onion Value Chain, published by the College of Agricultural Banking, Reserve Bank of India, 20-25% of onion production is lost due to post-harvest damages. This is because of the lack of storage infrastructure.

As the report points out:

“Nearly, 60% of the onion produced in Maharashtra during Rabi/ summer is available for storage i.e. 27 lakh tonnes out of total 45 lakh tonnes. The storage capacity created in the state through different government schemes is 8 lakh tonnes. These are scientifically built onion storage structures. Farmers store 5 lakh tonnes of onion in traditionally built local storage structures. Thus the total storage capacity in the state is 13 lakh tonnes.”

What this means that as of 2018, there was a need to create onion storage structures of additional 14 lakh tonnes, just in Maharashtra. Both the ECA and the lack of bank finance come in the way.

3) The ECA also leads to a situation where traders aren’t able to store enough and this creates problems. Let’s take a look at what happened last year. The ECA was invoked in end September. The onion inflation in the coming months just went through the roof (you can take a look at the inflation charts earlier). The stock limits basically ensured that traders couldn’t store onions beyond a point.

As the Economic Survey pointed out:

“Most of the kharif crop, which itself was lower, would have had to be offloaded in the market in October itself [thanks to the stock limits under the ECA]. Absent government intervention through ECA, traders would store a part of their produce to ensure smooth availability of a product at stable prices throughout the year.”

Of course, this does not mean that onion prices wouldn’t have gone up post September. They still might have gone up because of the lower kharif production, but the prices would have risen in a smoother way.

4) The government also resorts to export bans or increases the minimum export price of onions (where you can still export as long as the customer at the other end is ready to pay the higher price). The idea as mentioned earlier is to increase the supply in the domestic market.

In 2018-19, India exported around 22 lakh tonnes of the onions it produced. This was worth around $500 million. The total onion production during the year had stood at 228.2 lakh tonnes. Hence, less than 10% of the onion produced was exported. Also, the value of onion exports isn’t very big in the overall scheme of things.

As per a FICCI document, India’s export policy towards onions was changed 14 times between 2014 and 2019. This does no good to India’s image globally on the export policy front. It makes us look terribly unreliable.

Also, while prices in the Lasalgaon market fell on September 15, a day after the export ban, they have risen since then, and on September 23, the modal price of onion stood at Rs 3,600 per tonne. So much for the policy benefiting the consumer.

So where does all this leave us? The government has removed onions from the list of essential commodities in the hope that it leads to the development of storage infrastructure.

As Minister of State for Consumer Affairs, Food and Public Distribution Danve Raosaheb Dadarao told the Rajya Sabha:

“The stock limit conditions imposed through the law were hindering investment in the agriculture infrastructure… The move will boost investment in the agriculture sector and will also create more storage capacities to reduce post-harvest loss of crops.”

The move is also expected to increase the income of farmers.

The question is will this work out in the way the government is projecting it to be? Let’s look at this pointwise.

1) While, the government has removed onion from the list of essential commodities, its export continues to be banned. So, what kind of signal is being sent out to anyone who is interested in building agriculture infrastructure, including onion storage?

2) Even though onion is no longer a part of essential commodities, the government can still intervene, under extraordinary circumstances like war, famine, extraordinary price rise and a natural calamity of grave nature.

How is extraordinary price rise defined as?

“Any action on imposing stock limit shall be based on price rise and an order for regulating stock limit of any agricultural produce may be issued under this Act only if there is— (i) hundred per cent increase in the retail price of horticultural produce; or (ii) fifty per cent, increase in the retail price of non-perishable agricultural foodstuffs, over the price prevailing immediately preceding twelve months, or average retail price of last five years, whichever is lower.”

In the last three years, retail onion inflation has been more than 100% in eight months. Clearly, there is a good chance of high onion inflation in the time to come, given that any onion storage infrastructure isn’t going to be built overnight. Will the government intervene? Or will it sit tight and let the end-consumer pay?

The larger point here is that what the government does on this front in the time to come will determine how many entrepreneurs get interested in building agricultural infrastructure.

Just because onion is out of the essential commodities list doesn’t mean that the government cannot intervene. Any prospective entrepreneurs will like to see more evidence on this front.

3) There is great fear (as has been the case with the two main Farm Bills) of big business taking over. The question is if private enterprise is not allowed to operate in this sector, then what’s the way out? The government doesn’t have the money or the wherewithal to do much here. Central planning has been failure the world over and that it is a failure here as well, isn’t surprising.

Big business has built a lot of things since 1991, which most of us use and enjoy. Of course, along the way there has been crony capitalism as well. And that’s the fear here in the minds of people as well. (I don’t have a clear answer for this and I am saying so).

To conclude, taking onion out of the essential commodities list is just the first step. Many other things need to be done before the consumer can pay the right price and the farmer can get the right price.

In an ideal world, these are things that should have started in May 2014, when Narendra Modi was elected the prime minister for the first time. It would have been best to carry out small experiments in states and see how they go, before a nationwide plan was unleashed. There is always a gap between theory and practice and it’s best to correct that gap at a smaller level.

I would like to thank Chintan Patel for research assistance.

Why Farmers Are Protesting Against Laws Which Will ‘Supposedly’ Help Them

Over the last week many of you have asked me to write on this particular topic. One gentleman even suggested on Twitter, perhaps sarcastically, that I was slacking. (I guess after this 3,800 word piece, he will clearly not say that).

Well, I wasn’t slacking. This is a complicated topic with multiple issues and because of that I was trying to read as much as I could, before offering my views on the issue. (Also, I might be writing more on the issue in the days to come).

What do the Bills which have been passed by the Parliament seek to achieve?

Yesterday, the Rajya Sabha passed two out of the three Bills being referred to as the Farm Bills. These two Bills are the Farmers’ Produce Trade and Commerce (Promotion and Facilitation) Bill, 2020, and the Farmers (Empowerment and Protection) Agreement on Price Assurance and Farm Services Bill, 2020.

The Lok Sabha had already passed these Bills. There was some ruckus in the Rajya Sabha where the Bill was passed through a voice vote.

The Farmers’ Produce Trade and Commerce (Promotion and Facilitation) Bill, 2020, allows the farmers to sell their produce outside the Agricultural Produce Market Committee (APMC) regulated markets. The APMCs are government controlled marketing yards or mandis.

This law allows farmers to sell their produce to cold storages, warehouses, processing plants or even directly to the end consumer (you and I, restaurants, hotels etc.) The state government is not allowed from levying any market fee, cess or any other levy in these other market places (or trade areas). In short, anything that the state government can do is limited to the physical area of the APMCs. The Bill allows intra-state trade and inter-state trade.

So, the farmers clearly have more choice on who they want to sell. But they are still unhappy about it? Why? This is a question that will get answered in the piece.

Now let’s take a look at the other Bill.  The idea behind Farmers (Empowerment and Protection) Agreement on Price Assurance and Farm Services Bill, 2020, is essentially to create a framework for contract farming. This needs an agreement between the farmer and a buyer, before the production happens.

Of course, this hasn’t gone down well with the farmers either.

Why are the farmers protesting?

The passage of both the Bills hasn’t gone down well with the farmers. In fact, farmers in Punjab, Haryana and Western Uttar Pradesh, had been protesting even before the Bills were passed by the Parliament. Why has that been the case? Let’s take a look pointwise.

1) As mentioned earlier, the farmers of Punjab, Haryana and Western Uttar Pradesh, are the ones, primarily protesting. Hence, farmers across the country are not protesting against these Bills.

The farmers of these states are primarily protesting because the government procurement infrastructure in these areas is very good. This is primarily because the Green Revolution of the 1960s started here. In order to encourage farmers to adopt a new variety of wheat, the government offered procurement through the Food Corporation of India and a minimum support price (MSP) to farmers, which was declared before every agriculture season. Since then the system has evolved and the government sets an MSP on 23 agricultural crops, though it primarily buys only rice and wheat. In the recent years, it has bought some pulses and oilseeds as well.

The fear among farmers is that the next step in the agriculture reform process will be the doing away of government procurement process as well as the MSP. This is going to primarily hurt the farmers from Punjab and Haryana, who benefit tremendously from this.

2) The farmers who benefit from the government procurement process and MSP are medium and large farmers. As the document titled Price Policy for Rabi  Season—The Marketing Season of 2020-21, published by the Commission for Agricultural Costs and Prices 2020-21, which is a part of the Agriculture Ministry points out:

“As indicated by data received from some states, medium and large farmers occupy a major share in total procurement in the State and share of small and marginal farmers, though improved during last few years, remain low.”

Hence, it’s the bigger farmers who are protesting against the passage of these Bills. (It is important to make this distinction because the media is largely using the word farmers).

The government and Prime Minister Narendra Modi have assured that there are no plans to do away with government procurement or the MSP policy for that matter. The trouble is the protestors don’t seem to be buying these assurances and there is good reason for the same.

3) Why are the big farmers not buying the government’s assurances? The answer perhaps lies in the fact that it is but natural that the next step in the process of reforming agriculture is reforming government procurement and the MSP policy.

As NITI Aayog’s occasional paper titled Raising Agricultural Productivity and Making Farming Remunerative for Farmers published in December 2015, points out:

“There is a need for reorientation of price policy if it is to serve the basic goal of remunerative prices for farmers. This goal cannot be achieved through procurement backed MSP since it is neither feasible nor desirable for the government to buy each commodity in each market in all region.”

This paper essentially had the philosophical underpinnings on which both the Bills we have been talking about are based. Also, if the government purchases and the MSP are done away with, there will be further danger of free power, fertiliser subsidy etc., being done away with as well.

4) The MSP policy has led to excess production and excess procurement of rice and wheat by the government over the years. As of September 2020, the Food Corporation of India had 700.27 lakh tonnes of rice and wheat. As per the stocking norms for food grains, FCI needs to have an operational and strategic reserve of 411.2 lakh tonnes as of July and 307.70 lakh tonnes as of October. These massive stocks of rice and wheat are despite the government deciding to distribute a lot of rice and wheat for free to bring down the negative impact of the covid pandemic.

It has also led to farmers growing rice and wheat at the cost of other agricultural crops. As the NITI Aayog research paper referred to earlier points out: “Per capita intake and availability of pulses in the country has declined to two third since early 1960s. During the 50 years between 1964-65 and 2014-15, per capita production of pulses declined from 25 kg to 13.6 kg.”

Now, you cannot fault farmers for doing this. If they are incentivised to grow something, with a regular buyer available in the form of the government, they are bound to do that. Why take a risk, when a safer option where the government increases the price of rice and wheat every year, and buys what is produced, is available.

In fact, it is safe to say that if the government procurement is lowered (even without the MSP being done away with), the price of rice and wheat will fall. If private markets are established, it will fall even faster. This is something that the big farmers of Punjab and Haryana, don’t want, hence, the protests. It is worth remembering here that the marginal and small farmers, who own land of less than two hectares, are largely consumers of food, and food inflation tends to hurt them.

5) Let’s look at how strong the incentives of big farmers of Punjab and Haryana are. As the document titled Price Policy for Kharif Season—The Marketing Season of 2020-21 points out:

“For example, more than 95 percent paddy farmers in Punjab and about 70 percent farmers in Haryana are covered under procurement operations while in other major rice producing States like Uttar Pradesh (3.6%), West Bengal (7.3%) Odisha (20.6%) and Bihar (1.7%), very small number of rice farmers benefit from procurement operations.”

In total, the procurement system reaches around 11.8% of the rice farmers. This explains by the protests are limited largely to Punjab and Haryana.

6)  Punjabis themselves eat very little rice. But the solid procurement system in place ensures that the Punjabi farmers grow a lot of rice.

Procurement of rice in major producing states 2018-19.


Source: Price Policy for Kharif Season—The Marketing Season of 2020-21.

As can be seen from the above chart nearly 89% of the rice produced by the farmers in Punjab is procured by the government. In Haryana, it is 85%. Clearly, the farmers in Punjab and Haryana have a huge incentive in growing rice and doing away with price risk.

The government procurement system and the MSP have essentially ensured that semi-arid areas like Punjab and Haryana, grow rice, a crop which needs a lot of water. And this has created its own set of problems. “Continuous adoption of rice-wheat cropping system in North-Western plains of Punjab, Haryana and West Uttar Pradesh has resulted in depletion of ground water and deterioration of soil quality, posing a serious threat to its sustainability.” It also creates the problem of stubble burning during the winter months.

7) How do things look for wheat, the other crop procured majorly by the government? Take a look at the following table.

Statewise procurement of wheat.


Source: Price Policy for Rabi Season—The Marketing Season of 2020-21.

As can be seen from the above table Punjab and Haryana are again the major beneficiaries when it comes to procurement of wheat. Uttar Pradesh is the biggest producer of wheat but only around 11-12% of its production gets procured by the government.

As the NITI Aayog paper referred to earlier points out: “The pricing policy has also discriminated against eastern states where procurement at the MSP is minimal or non-existent. With part of the demand in these states satisfied by subsidised PDS sales of the grain procured in other states, prices of wheat and rice in these states end up below what they would be in the absence of price interventions of the government. The price policy has thus also created a regional bias in crop pattern as well as incomes of farmers.” The fact that inequality has gone on for years is disturbing. But this does not mean that the government should procure more rice and wheat from these states as well.

8) The other big fear among farmers, those representing them and many economists, is that large corporates will take over contract farming. The politicians suddenly want farmers to trust corporates and the market process, after spending decades abusing them. This is not going to happen suddenly, especially in an environment where there is big fear of large corporates taking over many other areas of business. All this is happening precisely at a time when the government has banned the export of onions. The messaging just isn’t right, given that if the government trusted the market process, it wouldn’t have banned the export of onions.

9) Another reason that farmers don’t trust corporates is the rise in their input costs. As the document titled Price Policy for Rabi Season points out: “The increase in cost of production was mainly driven by rise in farm input costs such as human labour, machinery, seeds, fertilisers, fuel, etc.” The belief is that this rise in prices is primarily because of the increasing corporatisation of the agri-input sector.

To conclude this section, the government procurement and the MSP where introduced in a certain time when India didn’t produce enough food grains to feed itself. These are policies of a bygone era and help only big farmers in certain states, and hence, they are the ones protesting, despite the assurances by the government.

Will the government be able to do away with procurement and MSP?

This is a tricky question. The procurement and the MSP system are one side of the equation, the supply side. On the demand side, the government sells the rice and wheat thus procured at heavily subsidised prices under the aegis of the Food Security Act, through lakhs of ration shops under the public distribution system.

So, while the big farmers of Punjab and Haryana might feel that the government will do away with procurement and MSP, it is not possible at one go. What is possible is that the government can cut down on procurement, in order to ensure that FCI does not have to maintain excess stocks like it has over the last few years.

The food subsidy system is a system which has been in place and which is much more complicated and much more spread across the country, than just the big-farmers of Punjab and Haryana. Also, with the covid pandemic, the importance of the food security system has clearly come to light. Actually, only once the government does away with the food security system can it do away with MSP and procurement. This is too big a challenge for any government.

Theoretically, it’s possible to do this and give cash handouts to people so that they can buy rice and wheat, but the political repercussions of doing away with food security the way it currently exists, is not something any government will be able to handle. It’s too big a risk.

This problem of  government assuming something and farmers believing the opposite, can only be solved if the two sides talk it out. But that is unlikely to happen, given that the Bills have already been passed.

Reform by stealth

Like has been the case with economic reforms in India in the past, this time was no different as well. The government resorted to reform by stealth and aggressively pushed the Bills through the Parliament, without either talking to the Opposition parties or farmer organisations.

This has led to the firm farmer belief that MSP and government procurement will go in the next round of reform. If the government had tried to talk to the farmers before pushing through the Bills that might perhaps have helped.

Secondly, if contract farming and trade markets other than APMC have to pick up, the state governments need to be on board as well. No corporate or businessman is going to attempt contract farming or setting up trade markets where agricultural produce can be sold by farmers, unless the state government is on board as well.

Hence, some talking would have helped. But then that’s not this government’s style.

My views

Let’s take a look pointwise.

1) There are multiple problems with the way the APMC markets across the country have been functioning. As the Sixty Second Report of the Standing Committee on Agriculture (2018-19), stated, highlighting some of the problems:

a) “Market Committees are reportedly democratic institution but in fact… [the] Committee is dominated by politicians and traders not by farmers as required.”

b) “The provisions of the APMC Acts are not implemented in their true sense. For example, market fee and commission charges are legally to be levied on traders, however, same is collected from farmers by deducting the amount from farmers’ net proceed.”

c) “Market fee is collected in some States even without actual trade-transaction has taken place and simply on landing the commodity at processing units. While in other States trade transaction outside the market yard is illegal.”

Once we take this into account, there is a clearly problem with the way APMCs function. Also, they restrict competition and tend to assume that the farmers are not smart enough to do their own thing (something that many politicians have made a career of). In that sense the freedom that these Bills provide the farmer are great.

Having said that, the absence of any regulation in non-APMC trade markets is not a good sign.

2) Are the farmers going to benefit almost overnight, as is being projected on the social media in particular and media in general? The simple answer is no. It needs to be pointed out here that as per the Agricultural Census of 2015-16, 12.56 crore or 86.2% of India’s operational holdings are small and marginal that is less than two acres in size.

Hence, most of the farmers really don’t produce enough to be able to deal with any marketing system, the old one or the new one, in a direct profitable way. For such small farmers to be able to benefit and get a better price for their produce without selling to a middleman, all kinds of other infrastructure is needed. These include everything from more cold storages to improved roads connecting villages to the newer markets that come up, power supply which can be relied upon (so that a cold storage can function like one) and traders who compete to get their produce.

All of this is very important if farmers are to get a better price for their produce. A survey carried out by the Reserve Bank of India and published in the central bank’s October 2019 bulletin found:

“The survey findings revealed that farmers’ average share in retail prices vary across crops between a range of 28 per cent and 78 per cent [across 14 crops]. The traders’ and retailers’ mark-ups were generally found to be higher for perishables than nonperishables.” The Survey also found that “retailers’ margins were generally higher than the traders’ margins in consumption centres across commodities, possibly due to significant product loss at the retail stage, particularly for perishables.”

In fact, the state of Bihar did away with the APMC Act in 2006 and didn’t get anywhere near higher incomes for farmers, given that the basic infrastructure to get market transactions going was not available.

This is why all the other infrastructure mentioned earlier becomes important. And it can’t be achieved without the active participation of the state governments. Hence, communication between the central government and the state governments on this issue is very important. And that hasn’t happened. Also, as usual, the central government hasn’t gone into the details. It has talked about how the farmers will benefit and is driving home that narrative aggressively, without really talking about the all the practical issues that will keep cropping up. (Remember demonetisation? Remember GST? Why does this feel like déjà vu?).

3) It is worth remembering that arthiyas (commission agents) who buy produce from farmers at APMCs, are locally influential people. Hence, assuming that parallel systems of buying and selling in the form of new trade markets, will come up automatically, is rather stupid. It is worth remembering that many arthiyas are themselves big farmers and can ensure that the system continues to work as it is. They might just move out of APMCs to avoid paying levies (which are very high especially in states of Punjab and Haryana at 8.5% and 6.5%, respectively). Everything else might continue to be the same. This depends on whether creation of new infrastructure is worth not paying the levy.

This is why, at the cost of repetition, proper healthy communication between state governments and the central government becomes very important. Also, it will be interesting to see whether the central government continues to procure rice and wheat through the Food Corporation of India (FCI) at the APMC mandis in Punjab and Haryana, using arthiyas and paying levies amounting to 6.5-8.5%? Or will it choose to move out, thereby hurting the revenue stream of the state governments? (Did someone say cooperative federalism?)

4) It is being assumed that buyers who currently buy from big commission agents, will start buying directly from farmers and let go of the middleman. There is a reason why these buyers buy from agents. It is convenient for them to do so. Do they want to take on the headache of building a new system right from scratch? Is it worth their time and money?

These are questions for which answers will become clearer in the days to come. But prima facie given the abysmal ease of doing business in most states, I see no reason why the buyers won’t continue buying from the agents, instead of having to deal with many farmers. As mentioned earlier, a bulk of India’s farmers are too small to benefit from any market- oriented system, unless they organise themselves in the forms of cooperatives and farmers-producer organisations.

Also, if governments really want to help these small and marginal farmers, they need to reform the change in land usage norms, and let farmers who want to sell their land be able to sell it anyone else and not just other farmers.

5) There is great fear of Big Business taking over agriculture. As per the Agricultural Census of 2015-16, the number of medium and large operational holdings is at 63.16 lakh (A medium sized operational holding has an area of 4 hectares to up to less than 10 hectares. And a large sized operational holding has an area of 10 hectares or more). These are huge numbers we are looking at. Just imagine the kind of scale needed to deal with these many number of farmers. If just take a look at large operational holdings, they are at 8.31 lakh. Hence, it’s not going to be easy for any corporate to do anything without involving middlemen.

If businesses just concentrated on states which have a higher proportion of medium and large operational holdings they are looking at Punjab (33.21% of the total operational holdings), Rajasthan (19.47% of the total operational holdings) and Haryana (14.35%). Not surprisingly, farmers of Punjab and Haryana are worried. They would rather deal with the known devil, the government, who, they can always vote out in the next election. But how do you vote out a corporate?

To conclude, the central government clearly hasn’t gone into the details of what will it take to really make the life of an average farmer better. As usual it is only interested in selling the narrative that the passage of these Farm Bills will ensure that farmers get a better price for what they produce. (Remember, the 50% higher MSP story they tried selling sometime back?)

When it comes to the opposition parties, they have managed to get low-hanging fruit to put the government on the mat after a while, and not surprisingly, they are cashing in on that.

Meanwhile, nobody is really worried about the farmer.

I would like to thank Chintan Patel for research assistance.