OPTIONS FOR RESTRUCTURING THE INDIAN WHEAT
MARKET
Steve McCorriston (University of Exeter, UK)
Donald MacLaren (University of Melbourne, Australia)
THIS VERSION: 10th FEBRUARY, 2011
Paper presented at the Final International Workshop on
“Facilitating Efficient Agricultural Markets in India: An Assessment of Competition
and Regulatory Reform”
New Delhi, India, 15th February, 2011
This research has been sponsored by the
Australian Centre for International Agricultural Research (ACIAR)
OPTIONS FOR RESTRUCTURING THE INDIAN WHEAT MARKET
Abstract
In this paper, we consider the role of the Food Corporation of India currently plays in
meeting the objectives of government policy via the procurement and distribution of
wheat. We provide a quantitative analysis of current arrangements and consider
alternatives whereby the role of the Food Corporation is reduced and the procurement
and management of wheat is increasingly accounted for by the private sector. These
issues are evaluated according to the degree of competitiveness in the private sector
and where the government uses alternative policy instruments to meet its twin
objectives of maintaining farm-level prices at a guaranteed level and where the
provision of low-cost food to the most vulnerable is met through a food stamp
programme. The results show that when the role of the Food Corporation is limited to
only procurement for the buffer stock, there are considerable welfare improvements
and both farmers and consumers benefit more when the marketing system becomes
more competitive. This finding underlines that, to capture the full benefits from
reform of the Food Corporation, a regulatory environment that encourages
competition will become increasingly important.
OPTIONS FOR RESTRUCTURING THE INDIAN WHEAT MARKET
1. Introduction
Pressures to reform government policy towards the Indian wheat and rice sectors have
increased in recent years. Low productivity growth, a slowdown in investment,
inefficient targeting of poor and vulnerable consumers, and the increasing cost of
surplus stocks, have exposed the need for a re-evaluation of the effectiveness of
agricultural policy aims and instruments currently employed in these key sectors. 1
Avoiding reform at this time will have consequences not only for poor farmers and
vulnerable consumers directly affected by the inadequacies of the current
arrangements but also for India’s future growth prospects more generally. To sustain
and support India’s growth potential which has become apparent in recent years,
policy reform that increases productivity and investment in agriculture while, at the
same time, ensuring food security for the large proportion of the population that lies
below the poverty line is a crucial combination that the Government of India needs to
address. Notable in this regard is that while reform of the current policy arrangements
is a key requisite for improving performance in the wheat and rice sectors and more
effectively providing safety nets for the most vulnerable, success of the reform
process will require complementary policies. These are required to ensure that these
sectors are appropriately regulated and create an environment in which competition
can develop while, at the same time, identifying the appropriate role for government
in correcting market failures that cannot be appropriately resolved by the market.
Key to addressing reforms in the Indian wheat and rice sectors is the role and
functioning of the Food Corporation of India (FCI) which is the principal means
1
For a recent critique of India's food-grain policy, see Basu (2010).
2
through which the Government of India’s management of these sectors is effected.
Yet the functioning of the FCI is characterised by inefficiency. By being charged with
dealing with various aspects of government policy, which are potentially conflicting,
its very presence as a principal participant in the wheat and rice sectors stifles the role
that private firms may play in these sectors. The purpose of this paper is to directly
assess the role of the FCI in the Indian wheat market by considering possible reform
options that may be used to meet the objectives of ensuring food security while, at the
same time, permitting a more prominent role to be played by the private sector in the
procurement and marketing of wheat. We do this in the context of a formal modelling
framework that allows us to assess a range of alternatives and to evaluate the costs
and benefits of current and alternative marketing arrangements across a variety of
metrics relating to economic welfare and food security.
The paper is organised as follows. In Section 2, we provide some background to the
recent pressures for reform in the Indian wheat sector and comment on the role
currently played by the FCI. In Section 3, we summarise the modelling exercise that is
reported in this paper by comparing an environment in which private firms alone
account for procurement (with respect to both domestic production and imports) and
distribution to consumers with the case where the government agency alone fulfils
these roles. Although this analysis is modelled using data from the Indian wheat
sector, it is not intended to comprehensively represent the actual situation (as we – at
this stage – omit other pertinent features of government policy in the wheat sector) but
rather the intention is to fix in one’s mind what the key issues are with respect to the
debate on the private sector versus state marketing and procurement and to employ a
range of different metrics against which to assess these issues. This forms the basis
3
for the discussion of the more specific role played by the FCI and the costs and
benefits of reform of the current marketing arrangements as the private sector is
allowed to play an increasing role in procurement and distribution with the proviso
that food security to the most vulnerable is maintained. In Section 4, we consider a
range of additional issues that relate to the role of the private sector and the potential
costs of alternative policy instruments that could replace the functions currently
carried out by the FCI including a policy of deficiency payments instead of
procurement to maintain the Minimum Support Price and a food stamp programme as
an alternative to the Targeted Public Distribution System. This analysis, therefore, ties
in market reforms with the Government of India providing safety-net measures by
other means, while reducing the dominance of the FCI in the market and the reliance
on the FCI to meet three objectives.2 In Section 5, we summarise the main insights
from this research and the implications for the future path for reform in the Indian
wheat sector.
2. Pressures for Reform in the Indian Wheat Sector
The key feature of agricultural policy in India is to provide access to low-price staples
such as wheat and rice especially to the poorest sections of society while, at the same
time, supporting agricultural prices and promoting price stabilisation through the
procurement and management of stocks of key commodities. These objectives are
potentially incompatible especially when there is a single intermediary charged with
implementing these policies, i.e., the Food Corporation of India. Furthermore, the
2
The objectives of the FCI are: (i) effective price support operations for safeguarding the interests of
the farmers; (2) distribution of food-grains throughout the country for public distribution system; and
(3) maintaining satisfactory level of operational and buffer stocks of food-grains to ensure National
Food Security (FCI, 2011a).
4
combination of high support prices, coupled with the slower growth in demand and
the inability to appropriately target poor consumers has led to the build up of excess
stocks which have to be managed by the FCI. As a consequence, the “food subsidy”
(the combined cost of the agricultural price support, the cost of distributing food to
the poor and the costs of stockholding) has increased substantially in recent years and
has placed considerable pressure on public expenditure. Specifically, by 2006, the
food subsidy amounted to Rs.155 billion which was up from Rs.135 billion in 2000,
and from Rs.130 billion in 1996 (Jha et al.,2007). The high and growing costs of the
food subsidy, together with the annual loss of millions of tonnes of food-grains
through inadequate storage, are the most evident signs of the pressure for policy
reform.
In more detail, farm prices are supported by the Minimum Support Price (MSP) which
is aimed at providing income support to farmers. To effect the use of the MSP, the
Government of India through the FCI will procure grain of ‘fair-to-medium’ quality in
surplus areas during harvest, with the support price for wheat being paid directly to
farmers in the markets in which they sell their grain. The private sector – which coexists with the FCI in the procurement of wheat – tends to purchase grain of higher
quality thus leaving the FCI to procure lower quality wheat. The wheat that is
procured via the MSP is distributed as subsidised food to the poor, occasionally as
exports or held as stocks. Though the MSP for wheat in real terms has declined since
the 1970s (Jha et al., 2007), supporting prices at the farm-gate is one of the main
mechanisms by which the Government of India can influence prices in agricultural
markets and meet its objectives of farm price support and price stabilisation.
5
Ensuring access to low-priced food for the most vulnerable was the function of the
Public Distribution System (PDS) which was the system for distributing subsidised
staple foods through (approximately 500,000) “fair price” outlets. This system was
reformed as the Targeted Public Distribution System (TPDS) in 1998/99 which
increased the subsidy component of low-price food to consumers below the poverty
line and with a higher price to those consumers above the poverty line. The cost of
distributing subsidised food is considerable; Jha et al. note that prices for below-thepoverty-line consumers were 33-38 per cent below the previous PDS prices and
covered approximately one-third of the costs of the FCI subsidised distribution while
prices to consumers above the poverty line covered around 60 per cent of the FCI’s
costs of distributing wheat. Other mechanisms by which the poor are targeted include
food-for-work programmes and school lunches (see FCI (2011b) for a list of other
welfare programmes involving subsidised food grains).
International trade has been largely managed by the FCI. Traditionally, India has been
a net importer of wheat but, with the increase in domestic production, it has become
an occasional exporter to world markets. In more recent years, India has again faced a
moderate wheat deficit and relied on imports from the world market. The principal
mechanism for managing trade is the FCI which traditionally has maintained
exclusive rights over exports and imports, thus maintaining a dominant role over all
traded staple commodities. Even when private traders have been permitted to engage
in trade, the FCI has retained its dominant role. The potential trade distorting effect of
state trading enterprises such as the FCI in wheat and rice trade has been explored by
McCorriston and MacLaren (2006) where they highlighted that managing trade in this
way would be equivalent to an import tariff/export subsidy beyond the bound tariff
6
rates typically reported in publicly available documents. In other words, managing
trade through the FCI acted as another distortion to trade beyond more standard trade
policy instruments.
Setting aside the issue of whether using support prices to raise farm incomes and
subsidised prices to ensure access to food to the poorest are compatible aims of
policy, especially when carried out by a single agency as the FCI, one of the features
of the current operations of policy has been the inefficiency associated with the FCI in
carrying out its principal functions. Despite the widespread coverage of the TPDS,
most of the poor still rely on the commercial market for purchasing staples (Jha et al.,
2007). Moreover, operating the TPDS is costly; Jha et al. report that, to transfer
Rs.1.00 to the poor costs Rs3.14 in the State of Andhra Pradesh and Rs4.00 to transfer
the same amount in the State of Maharashtra. Breaking down the costs of transferring
subsidised food, 16-26 per cent was due to high costs of grain transport, handling and
storage, 26-31 per cent was accounted for by transfers to non-poor households, and
15-28 per cent due to so-called ‘leakages’ where subsidised food finds its way back
onto the commercial market. Ramaswami (2002) reports that only 32 per cent of
subsidy expenditure reached the targeted groups in the State of Maharashtra. Persaud
and Rosen (2003) also report comparable levels of costly distribution in the
functioning of the PDS. More recently, Khera (2010) reports that 67 per cent of wheat
aimed at the poor missed its target group.
This brief overview of the Government of India’s policy in the wheat sector clearly
shows that current policy arrangements are both costly and ineffective. Further, the
role of the FCI is the main mechanism by which wheat is procured, stored and
7
distributed and is the main means via which current policy objectives are met. The
current failures of policy in the Indian wheat sector need to be addressed and other
instruments by which the aims of government policy can be met need to be
considered. These issues arise against a background of low productivity growth and
weak investment in agriculture both in comparison with growth and productivity in
the rest of the economy and also in relation to the performance witnessed in other
BRIC countries. Specifically, the growth rate in gross domestic product in agriculture
between 1997 and 2004 averaged 1.8 per cent per annum compared with growth in
the economy of 5.8 per cent per annum over the same period (Landes, 2008).
Similarly, over the period 1997-2004 investment in agriculture also lagged behind the
general economy with the growth in investment being 3.9 per cent per annum in the
agricultural sector compared with 11.3 per cent per annum for the whole economy.
Compared with other BRIC countries, investment in Indian agriculture as a
percentage of GDP was 6.6 per cent for the 2003-2005 period which is considerably
lower than the 48 per cent for Brazil (2001-2003 average), and 9.6 per cent for China
(2003-2005 average) (Landes, 2008).
Addressing the potential for reform of the current functioning of policy in the wheat
sector can be seen, therefore, as a requirement for providing the basis of a more
productive agricultural sector and one that is more efficient in marketing food
products to consumers while, at the same time, ensuring that the mainstays of the
government’s objectives of ensuring food security and providing a floor price to
vulnerable farmers are met. Central to this package of reforms is the role of the Food
Corporation and raises the question whether the role of this state enterprise inhibits
the performance of agricultural policy and whether a marketing system with a greater
8
role played by private firms together with a diminishing the role of the FCI, can
improve welfare and food security. To do this, the potential role of the private sector
has to be considered in the context of using alternative policy instruments to ensure
floor prices at the farm gate and access to cheap food by the poorest consumers. These
are the issues that we consider in the remainder of this report.
However, encouraging the development of private sector competition will require a
broader menu of reforms and policy initiatives. There is a wide range of regulations
and restrictions that currently exist that inhibit private sector investment in the food
supply chain and the entry of new firms. These include taxes on processed food,
insufficient investment in infrastructure, restrictions on the size of firms in the
agribusiness sector, restrictions on transportation and storage and on foreign
investment in the food retailing sector, as well as the lack of effective and appropriate
grading and inspection systems (Landes, 2008). Thus, in considering the overall
development in the food sector in the absence of the FCI, it is also relevant to identify
issues that will determine the overall effectiveness of competition throughout the
marketing chain and, more generally, the broader regulatory environment in which
private firms will compete. We analyse these issues indirectly, by comparing the
policy options with regard to the role currently played by the FCI against alternative
characterisations of the overall competitiveness when private firms alone characterise
the wheat marketing chain.
3. State Procurement and Distribution versus the Private Sector
Key to addressing policy reform options in the Indian wheat sector and the overall
effectiveness of marketing arrangements is the role of the Food Corporation of India.
9
As noted above, the FCI currently plays a key role in the procurement and distribution
of wheat and has the remit of implementing the key instruments of agricultural policy.
While we consider alternative policy instruments below, we also need to consider the
possibility that if the FCI does not exist (or at least that its obligations change), private
firms will increasingly play a part in the overall marketing arrangements in the wheat
sector. In this section, we therefore focus on two broad issues. First, as noted above,
the FCI is characterised by inefficiency and we consider the case where the FCI’s
costs reflect various degrees of inefficiency associated with procurement and
distribution. Second, we compare the state enterprise scenario with private firms coexisting with the FCI but with no agricultural policy instruments in place. While this
is not realistic given the Government of India’s stated concerns of income support at
the farm level and ensuring access to food by poor consumers, it does provide a
benchmark against which the various policy options can be compared, where the role
of the FCI is constrained and where private firms increasingly feature in procurement
and distribution in the Indian wheat sector.
The basis of the analysis provided here is a theoretical open-economy model which
can be calibrated with data which then forms the basis for considering alternative
reform scenarios including alternative roles for the FCI co-existing with (varying
numbers of) private firms in all or limited segments of the wheat market. To expedite
the discussion and to focus on the principal insights from this outcome, we refer the
interested reader to our related work on partial reforms of state trading in McCorriston
and MacLaren (2011) which details the theoretical framework employed. To provide
some detail, the theoretical model that we develop for this analysis is calibrated with
data in 2008/09 for the Indian wheat sector. In this way, the formal framework
10
underpinning the analysis to scenarios that directly relate to the main reform issues in
the Indian wheat market and therefore they give a detailed insight into the potential
costs and benefits of policy reform. We conduct the analysis in two steps. In the first
step, we consider the potential effect of a competitive private sector replacing state
procurement and marketing but where other government policy instruments are absent
from the market. This allows us to focus on the potential impact of de-regulation of
the FCI with private firms becoming an increasingly important feature of the
marketing regime for wheat; second, we go on to consider not only the significance of
the FCI in procurement and distribution, but limiting the role of the FCI while using
alternative policy instruments to meet safety net objectives of government policy. In
this context, the quantitative results should be interpreted as the relative impact that
may arise from different reform configurations.3
The focus of the comparison of alternative policy options will be across various
metrics which reflect different perspectives on the role and purpose of government
policy. These metrics are: (i) net social welfare; (ii) producer and consumer surplus,
the latter being associated with purchases on the commercial market only, these
measures reflecting the distributional aspects of policy; (iii) food availability as
measured by the level of self-sufficiency (domestic production/domestic production
plus imports) and total availability (domestic production plus imports) and (iv) the
impact of any reforms with reference to farm-gate and consumer prices4.
3
In comparing results, we therefore benchmark the base scenarios in each case at 100 to focus on the
relative changes that may arise rather the exact quantitative impact that may be expected.
4
As noted above, much of the concerns of many countries regarding food security issues in the context
of exogenous shocks has related to the 2007-2008 price spike. In the analysis conducted here, we could
focus on shocks emanating from the domestic agricultural sector. The reason for this is that, with the
data used for the model calibration, the level of trade in wheat was minimal and therefore it would be
more appropriate to gauge the price transmission effects associated with shocks in the domestic sector.
However, we do not evaluate the effect of production shocks on prices because we are not directly
11
We start by measuring the potential effect of a welfare maximising state enterprise; as
noted above, one of the key criticism levelled at the FCI is its inefficiency and we
assess what potential impact inefficiency of a state enterprise has on the distributional
and net welfare effects. The inefficiency aspects of the state enterprise are associated
with its costs being higher than what may be expected with a private firm benchmark.
We consider two levels of inefficiency; one where the state enterprise’s costs are 25
per cent higher than would be expected and the other where the costs are 50 per cent
higher. The effects of this are reported in Figure 1. As can be clearly seen,
inefficiency in the procurement and distribution of wheat reduces net welfare
significantly: with the degree of relative inefficiency being 25 per cent, social welfare
arising from the use of a welfare maximising FCI is reduced by 11 per cent.
Increasing the degree of relative inefficiency to 50 per cent reduces social welfare by
around 21 per cent. In terms of the effects on the distribution of welfare, both farmers
and consumers are negatively affected by state inefficiency; with relative inefficiency
at 25 (50) per cent, producer surplus is reduced by 10 (18) per cent while consumer
surplus is reduced by 8 (15) per cent respectively. The other component of welfare
(not reported in the figure) is that when the state enterprise is efficient, it runs a small
operating profit on importing (its profit on domestic procurement and sales is zero
because it is welfare maximising) but inefficiency turns overall profit into a
substantial loss.
modelling the effects of variability, except to the extent that we incorporate a guaranteed price as way
of moderating down-side producer price risk..
12
Figure 1: Welfare Impact of an Inefficient, Welfare Maximising State Enterprise
0
% Change in
Social Welfare
-5
% Change in
Producer
Surplus
% Change in
Consumer
Surplus
-10
25% less efficient
% Change
50% less efficient
-15
-20
-25
The food security implications are reported in Figure 2. The inefficiency of the state
enterprise has, most notably, a strong impact on the total availability of wheat; while
there is little noticeable effect on self-sufficiency (largely because inefficiency
negatively impacts on domestic procurement and imports and the marketing of both),
the total wheat available decreases by as much as 8 per cent with 50 per cent relative
inefficiency. Consumer prices rise by as much as 11 (20) per cent when the state
enterprise is 25 (50) per cent inefficient and farm-gate prices fall by 8 (14) per cent
under the same scenarios.
13
Figure 2: Food Security Implications of an Inefficient, Welfare Maximising,
State Enterprise
25
20
15
10
5
25% less efficient
0
50% less efficient
% Cha nge
-5
-10
Change in Total
Availability (%)
Change in
Consumer
Prices (%)
Change in Farm
Gate Prices (%)
-15
-20
Consider the alternative to a welfare maximising but inefficient state enterprise with a
marketing system characterised by competition between private firms. Remember
that, at the present time, we are comparing alternative structures to the wheat
marketing system in the absence of any agricultural policy instruments, so the
comparison for the present is solely between a state-dominated system and a private
firm environment. In addressing the role of competition, including concerns that a
(welfare maximising) state enterprise system may be replaced by private firms
exercising market power, we consider a range of scenarios where we vary the number
of firms competing in the market. Three alternatives are considered: one where the
market is characterised by oligopoly/oligopsony – for this, we set the number of firms
equal to 4; another scenario where the market is reasonably competitive – here the
number of competing firms is set to 20; and finally a more competitive environment
where the number of competing firms equals 100. For the sake of our evaluation, we
14
compare the private sector outcome with the state enterprise that is 50 per cent less
efficient than the private firms. With this set-up, there are therefore two principal
differences when comparing these alternative market structures: first, that the
objective function of the state enterprise differs from that of private firms (welfare
maximising versus profit maximising); second, the state enterprise’s costs are 50 per
cent higher than the private firms’ costs.
The results from comparing the private firm market structure with the inefficient state
enterprise on welfare are reported in Figure 3. With a moderately competitive private
firm environment (n=20), social welfare is 25 per cent higher than in the inefficient,
state-dominated case; with a more competitive environment, social welfare increases
by 26 per cent. With a small number of firms (n=4), social welfare increases by 18 per
cent. Both farmers and consumers potentially gain in the private firm case when there
are a ‘reasonable’ number of firms competing in the market, when there are no
additional government policies in place and in comparison with where the state
enterprise is explicitly concerned about producer and consumer welfare. For example,
with n=20, producer surplus is 8 per cent higher in the n=20 firm scenario, while
consumer surplus is 7 per cent higher. The losses of the state enterprise are turned into
considerable profits, with the marketing margin between retail and farm-gate prices
being 15 per cent in the 20-firm scenario, though this decreases to 9 per cent in the
more competitive (100 firm) case.
Note from Figure 3 that, while the results suggest an increase in social welfare in all
cases, producers and consumers lose in the case with a small number of private firms
(n=4). This seeming disparity between this case and the other two where producer and
15
consumer surplus increase is due to the fact that in the small numbers case, the large
marketing margin is reflected in high profits for the private firms. This underlies a
central point in the policy implications in the analysis conducted here; the gains from
encouraging competition in the wheat sector require that there is a regulatory
framework that ensures competition is effective so that the potential gains to
consumers and producers actually materialise.
Figure 3: Welfare Implications of Private Firm Scenarios with Welfare
Maximising, Inefficient State Enterprise
30
20
10
n=4
% Cha nge
0
n=20
% Change in Social
Welfare
% Change in
Producer Surplus
% Change in
Consumer Surplus
n=100
-10
-20
-30
Figure 4 reports the results relating to the food security implications from this
comparison. There is a negligible effect on self-sufficiency (largely because, as we
noted above, the effect of changing market structure impacts on both domestic
procurement and imports) though total availability of wheat available increases by 8
per cent in the 100-firm case when compared with the inefficient state enterprise and
by 4 per cent in the less competitive (n=20) case. Reflecting these changes, retail food
16
prices are 14 per cent lower and farm-gate prices 14 per cent higher in the most
competitive case, the lower retail and higher farm-gate prices reflecting the decline in
marketing margins in the more competitive case. Note, however, the outcome with a
relatively low level of competition: total availability declines (by 13 per cent),
consumer prices rise (by 25 per cent) and farm-gate prices fall by the same margin. As
noted above, these results underpin the importance of effective competition if reform
of the FCI is likely to be successful.
Figure 4: Food Security Implications of Private Firm Scenarios with Welfare
Maximising, Inefficient State Enterprise
30
20
10
n=4
% Change
0
n=20
Change in Total
Availability (%)
Change in Consumer Change in Farm Gate
Prices (%)
Prices (%)
n=100
-10
-20
-30
A word of caution in interpreting these results should be noted at this point. Here we
are comparing the private sector with a state enterprise which, though relatively
inefficient, is nevertheless maximising both consumer and producer welfare. If we
were to dilute this objective function of the state enterprise, then the evaluation will
change. Assuming the state enterprise focussed on profits only (whether these were
17
positive or negative), the more competitive (n>1) outcomes would always dominate
the state enterprise case. This therefore suggests that, in considering the impact of deregulation, there are factors that are potentially offsetting and this suggests that care
has to be exercised in identifying closely what the ingredients of the reform package
are. In the welfare-maximising case, the state enterprise is already charged with the
aim of re-distribution even if other policy instruments are not being used and it has
the potential to dominate the private firm outcome. But this need not always be
guaranteed and any deviation from this welfare maximising case will cause the state
enterprise scenario to be dominated by the private sector outcome (see McCorriston
and MacLaren (2011) for further discussion of this).
In the final comparison of alternative market structures of the wheat marketing chain,
we consider the case where the state enterprise co-exists with private firms rather than
comparing the polar opposites. This example is important since, across many
countries (including India) where state enterprises are involved in procurement and
distribution, this co-existence is likely to be the most typical market structure.
However, it is often the case that when the state enterprise does co-exist with private
firms, the government bestows exclusive rights to the state enterprise, i.e., the
government determines in which markets private firms can operate, leaving the other
segment of the market exclusively to the state enterprise. A common example of this
would be where the state enterprise has exclusive rights over international trade. In
this case then, we have three aspects of the potential asymmetry between the state
enterprise and private firms: the objective functions may or may not differ; the state
enterprise may be relatively less efficient than the private sector counterparts; the state
enterprise may have sole rights in the procurement/distribution in specified segments
18
of the market. The results below relate to the case where the state enterprise has
exclusive rights over the procurement of imports but competes with private firms in
the procurement of domestic output and with private firms in the distribution of both.
The comparison made is with the polar opposites reported above: i.e., with an
inefficient state enterprise that exists alone and with a private firm benchmark
comprising 20 firms.
The welfare comparisons are reported in Figure 5. The welfare outcomes with the coexistence of the state enterprise and private firms lie between the state enterprise only
case and the private firm only case with the net welfare effect being closest to the
former scenario. Specifically, welfare is approximately 3 per cent higher compared to
the inefficient state enterprise alone but 17 per cent lower than the private firm only
case. Note, that in this comparison, in the case where both private firms and the state
enterprise co-exist, we have the same number of market participants in both scenarios
(i.e. 20 private firms or 19 private firms plus the state enterprise) but in the state
enterprise case it has exclusive rights in the import market and we revert to the case
where its objective function is to maximise welfare. This suggests that, while
introducing private firms to compete with the state enterprise improves the overall
welfare outcome, it still falls far short of the welfare improvement that could
materialise if the state enterprise was privatised, it improved efficiency commensurate
with the private sector and it maximises profit in competition with private firms. In
terms of the effects on producer and consumer surplus, producers and consumers both
lose relative to the welfare maximising state enterprise case and they also lose
compared with the case where there are only private firms (n = 20).
19
Figure 5: Welfare Implications of Private Firms Co-existing with Welfare
Maximising, Inefficient State Enterprise
5
0
-5
% Change in
Social Welfare
% Change in
% Change in
Producer Surplus Consumer Surplus
-10
Inefficient SE
% Change -15
n=20
-20
-25
-30
-35
Interesting effects arise when the focus turns to food security metrics which are
reported in Figure 6. In the case with the welfare maximising, state enterprise coexisting with private firms, while self-sufficiency remains largely unaffected, total
availability of wheat is less than in the two cases; relative to the inefficient, state-only
case, total availability is 11 per cent lower and, with respect to the private firm case,
approximately 14 per cent lower. Consumer prices are higher in this joint case by
approximately 29 per cent relative to the private firm only case and 21 per cent higher
compared with the state enterprise only case. Farm-gate prices are 20 per cent lower
relative to the state only case and 25 per cent lower compared with the private firm
only case.
20
Figure 6: Food Security Implications of Private Firms Co-existing with Welfare
Maximising, Inefficient State Enterprise
40
30
20
10
Inefficient SE
% Change
n=20
0
-10
Change in Total
Availability (%)
Change in
Consumer Prices
(%)
Change in Farm
Gate Prices (%)
-20
-30
We can summarise the main insights from the above analysis as follows:

The inefficiency associated with the operations of the state enterprise has a
considerable impact on social welfare and the distribution of that social
welfare as well as in relation to various metrics associated with food
security. Notwithstanding other reforms to the wheat marketing sector in
India, addressing the inefficiency associated with the operations of the FCI
could bring substantive benefits.

Allowing private firms to compete with the FCI will bring substantive
benefits to producers and consumers and lead to an improvement in food
security. This is true whatever the objectives of the state enterprise are,
21
whether they relate to welfare distribution or focuses on profits only (and
whether these profits are positive or negative).

Building on this scenario, creating an environment where an increasing
number of private firms can compete in the marketing chain, even in the
presence of the state enterprise, will improve economic welfare but will
reduce food security and the more competitive the environment becomes,
the greater the potential welfare benefits from reducing the role of the FCI.

Comparing the more abstract case of a state enterprise and the private firm
alternative depends largely on the objective function of the state enterprise.
If the government details the objective function to be welfare
maximisation, then there is the potential that it could dominate the private
sector outcome. However, any deviation from this, will increase the
attraction of the private sector alternative. Thus, in considering the issues
of de-regulation, one should consider what the precise responsibilities of
the state enterprise are, and how well it meets them. A successful, efficient
and welfare maximising state enterprise is likely to be rare.

When considering the nature of private sector outcomes, more competitive
environments do better across almost all metrics and bring the outcome
closer to the welfare maximising ideal outcome.
4. The Food Corporation of India and Alternative Policy Instruments
In this section, we build on the analysis above to focus more directly on the
responsibilities of the FCI and what policy options exist while maintaining the overall
22
objectives of government policy towards both farmers and consumers. The insights
above highlight the role that competition in the wheat marketing chain could play in
improving welfare for both consumers and producers and the potential implications
for food security and under what circumstances they are likely to prevail. But the
discussion focussed on market structure issues only and did not address the direct
functions of the FCI in terms of maintaining the MSP or procuring wheat for public
distribution to vulnerable groups or for the build-up of stocks. This is important. The
textbook example of a welfare-maximising state enterprise has some merits but when
governments employ state enterprises to influence the functioning of markets with
the use of other policy instruments with the aim of ensuring certain policy outcomes,
the situation is likely to be altered. We therefore extend the analysis of the wheat
marketing chain and focus more directly on the details of the Indian wheat sector by
analysing the role of an inefficient FCI co-existing with private firms in the context
that the minimum support price is maintained by FCI purchases and that the private
firms procure from domestic producers (and, at the margin, via imports) which are
sold on the domestic commercial market. The FCI’s procurement is directed to stocks
and distribution via the TPDS. We highlight the welfare and food security
implications of this by comparing the FCI’s role in achieving these objectives when
the commercial market is relatively competitive and when it is less so. Specifically,
the inefficient FCI retains these roles in the procurement and distribution of wheat,
but we vary the number of private firms competing in that context. We then proceed
to assess alternative policy options with the government meeting these objectives but
using different policy instruments (specifically a deficiency payments policy and
targeting poor consumers through the use of a food stamp programme) and with the
23
role of the FCI limited to procuring wheat from the agricultural sector but only for the
purposes of maintaining the buffer stock.
(i) The FCI Current Regime and Competition in the Marketing Chain
In Figure 7, we report the results from evaluating the FCI’s current role but in the
context of varying the number of private firms that compete in the wheat marketing
chain. In terms of characterising the FCI, we assume that it is relatively inefficient
compared with the private sector firms, its procurement aimed at ensuring the MSP
and with its procured quantities being held in the buffer stock or distributed via the
TPDS.
Specifically, in the context of the current policy framework, a more
competitive environment (n = 20) increases net social welfare by around 6 per cent
compared with n = 4. But as the comparison in Figure 7 shows, the re-distributive
aspects of private firm competition are more substantive: with a larger number of
private firms, producer surplus is 18 per cent higher and consumer surplus 42 per cent
higher compared with the FCI operating in a less competitive environment. Food
availability is higher in the more competitive case (despite additional purchases of the
FCI to maintain the MSP-see discussion below) by around 19 per cent though, as
noted before, there is little difference on the self-sufficiency ratio between the two
cases. In the more competitive case, retail (farm-gate) prices are 17 per cent lower (13
per cent higher) compared with the less competitive environment. With higher farmgate prices and lower retail prices, one of the main effects of the more competitive
environment is that the retail-farm-gate mark-up is approximately 68 per cent lower in
the more competitive case.
24
Figure 7: The Current FCI Regime and the Degree of Competition in the
Marketing Chain.
50
40
30
20
% Cha nge
10
0
% Change in % Change in % Change in Change in
Social
Producer
Consumer
Total
-10
Welfare
Surplus
Surplus
Availability
(%)
Change in
Consumer
Prices (%)
Change in
Farm Gate
Prices (%)
-20
One of the main differences that arise when we compare the competitive environment
is the public expenditure costs of the policies. Clearly, with the TPDS, the
government exchequer has to cover the cost of subsiding low-cost food to the most
vulnerable through the TPDS. Also, with the FCI charged with maintaining the MSP,
if farm-level prices were to fall below the MSP, FCI procurement would have to
increase to support the stated Minimum Support Price. When the number of private
firms that co-exists with the FCI is low, retail prices are relatively high and, because
of the oligopsony power the few firms have with respect to procurement, the farmgate price is low. This results in a relatively high subsidy outlay by the FCI in the
distribution of low-cost food and relatively high outlays to support farm-gate prices.
In terms of gauging the public expenditure impact, we measure the costs of these
activities relative to the social costs of the current FCI regime (assuming a small
25
number of firms) as a whole. It is clear that the costs of supporting the MSP and the
TPDS are expensive if competition among private firms is limited, the cost of these
activities amounting to around 37 per cent of the net social welfare effect. However,
with a more competitive environment, farm-gate prices are bid up (because
competition in the procurement market raises prices), such that the role of FCI in
maintaining the MSP becomes unnecessary. In this case, the cost to the public
exchequer lies only with the TPDS but the costs of this policy remain at around 37 per
cent of the net social welfare effects because the higher procurement cost almost
offsets the savings from not having to purchase to maintain the MSP.
(ii) The FCI, Competition and Alternative Policy Instruments
In the final step in our analysis of the Indian wheat marketing system, we amend the
policy instruments the government uses to meet its objectives of supporting farm-gate
prices and providing access to low-cost food to the most vulnerable. However, rather
than use the MSP, we assume that the government uses a deficiency payments policy
to ensure that farmers receive a guaranteed price for their output. Thus, whatever the
level of competition in the procurement market, if the procurement price is below the
guaranteed price, the government makes up the difference through direct payments
rather than the FCI procuring directly in the agricultural market to raise prices to the
stated minimum support level. With respect to targeting the poorest and ensuring
access to low cost food, we assume that the government instead uses a food stamp
programme.5 Note that, in this analysis, we are abstracting from considering issues
associated with the practical implementation of these alternative policy instruments
5
In assessing the pilot food stamp programme in Maharashtra, Ramaswami and Murugkar (2005)
report that the government of that State provided food stamps which were worth one-quarter of the cost
of food-grains. We use this same proportion in calculating the budgetary cost of the food stamp
programme.
26
and consider only the impact they will have on the distribution of welfare and food
security metrics.6
In the results presented below, we compare the deficiency payments/food stamp
scenario with the case with the current MSP/TPDS regime. In both cases, we assume
that competition from private firms is limited, the reason being that with a small
number of private firms, the greater the likelihood that the guarantee price would have
to be binding. The results presented show improvement with this new policy across all
metrics, with the exception of the producer price and producer surplus, which is
maintained at the same level across both scenarios, i.e., the guaranteed
price/deficiency payments policy gives the same outcome to producers as the MSP
when the number of private firms is low but with policy being met by public
expenditure changes rather than by purchases by the FCI to maintain the MSP. The
results from this comparison are reported in Figure 8.
Specifically, maintaining the objectives of policy in terms of providing current safety
nets but reducing the FCI’s function to procuring for the buffer stock only, may
increase social welfare by as much as 82 per cent. The percentage increase depends
on the procurement price set by the private firms, a price that is indeterminate.
However, if the profits of these firms are held constant at the value that would pertain
were the guaranteed price not present, then there is a unique procurement price. As
noted, producer surplus remains unchanged but total consumer surplus increases by
159 per cent; this is reflected in lower consumer prices (by 25 per cent) and the total
availability of wheat increases by 18 per cent. This clearly shows that the FCI ‘crowds
6
Ramaswami and Murugkar (2005) provide practical details of how the pilot food stamp programme in
Maharashtra was designed.
27
out’ the private sector such that there are potentially substantive potential benefits
from reform even if current safety nets are retained but met by other means.
Moreover, since the combination of food stamps and deficiency payments is more
direct, the costs of this policy to the public exchequer also falls, by around 13 per
cent.
Figure 8: The Current FCI Regime and the Potential Effects of Deficiency
Payments Policy and a Food Stamp Programme
200
150
100
% Change
50
0
% Change in
Social Welfare
-50
% Change in
Consumer
Surplus
Change in Total
Change in
Availability (%) Consumer Prices
(%)
(iii) Summary and Principal Observations
There are several important implications that arise from this analysis of the current
role of the FCI and the policy options that are available while maintaining the overall
objectives of government policy in the provision of safety nets. These are summarised
below:

Retaining the structure of the current regime and retaining the responsibilities
of the Food Corporation of India, but improving the efficiency of its
28
operations could bring significant benefits to consumers and producers and
improve food security.

Retaining the current regime and providing an enabling environment in which
private firms can enter and compete more effectively in the procurement and
marketing of wheat would likely bring significant benefits.

Maintaining the policy objectives of the government but achieving them
through the use of other instruments, while minimising the role of the Food
Corporation, could bring significant benefits in welfare, principally
consumers, without adverse effects on producers.
5. Conclusions
The continued growth of the ‘food subsidy’, low productivity growth and inadequate
investment in Indian agriculture and the inefficiency in the functioning of the Food
Corporation of India are the factors that create the pressure for reform. Central to
these reforms is changing the role of the Food Corporation. Given its dominant status
in the procurement and distribution of wheat, the future role of the Food Corporation
of India will be central to the reforms that should take place. Clearly, as one considers
its future role, the question arises of what net benefits more competition in the wheat
marketing sector can bring. But, at the same time, the Government of India faces the
very real constraints of its stated objectives of maintaining farm incomes and ensuring
that low-cost food is available to the most vulnerable. It is this issue of the reform of
the Food Corporation, subject to the constraints of the provision of these safety nets,
together with the potential role of the private sector that has been addressed in this
paper.
29
To assess these issues, we have drawn on a theoretical framework calibrated with data
that characterises the Indian wheat market. We have analysed the issue of reform from
two directions. First, we considered the role of a welfare maximising, potentially
inefficient state enterprise against the potential alternative of private firms alone
characterising the wheat marketing sector. In this context, we abstracted from the
availability and use of other policy instruments other than the manipulation of the
market via the state enterprise. The analysis suggests that there are potential gains
from improving the efficiency of the FCI and that the relative merits of the private
sector depend on fully understanding the objectives of the state enterprise. Anything
other than a highly efficient, welfare maximising state enterprise will likely lead to
inferior outcomes compared with those that would materialise with private sector
competition. If the FCI did not characterise the market, the more competition there is,
the greater the potential benefits for both farmers and consumers and across various
metrics that relate to food security.
Building on this framework, we then explored the options for the FCI as it currently
operates and its mandate in managing the TPDS and the MSP. Again, in this context,
we allowed the FCI to be less efficient than private sector firms. We then compared
the likely impact of more competition even under the current regime and subsequently
analysed whether the role of the FCI could be limited to procurement for the buffer
stock only while the other two objectives of government policy could be met by other
means such as a guaranteed price and deficiency payment, and a food stamp
programme. As we show, there are substantive potential benefits available both in
welfare terms and across various food security metrics.
30
The overall message from this analysis is that there are substantive benefits available
from reform, that encouraging more competition will likely ensure the greatest gains
while, at the same time, not diminishing the importance of the objectives of
government policy in terms of floor prices at the farm gate nor providing access to
low cost food for the most vulnerable. There are, of course, caveats to add to this
analysis. First, ensuring that competition does bring benefits will require a range of
complementary policies, including a regulatory framework, to ensure that competition
is effective and that other market failures, which may inhibit the activities of private
firms, are appropriately corrected. Second, while the emphasis has been on
competition issues and the de-regulation of the FCI, the alternative policies have to be
fully evaluated and administered effectively, the results here being only indicative of
the possible net benefits. Finally, and importantly in an environment of volatile prices,
the relative merits of the state in procurement and distribution when measured against
the private sector, and the links between risk and market structure with and without
the use of contingent markets, need to be fully assessed, as well as the benefits that
private firms may bring in the amelioration of the effects of risk on both farmers and
consumers through the use of vertical contracts with the upstream sectors.
31
References
Basu, K. (2010) ‘India's Foodgrain Policy: An Economic Perspective’, Economic and
Political Weekly, XLVI(5): 37-45, January 29.
FCI (2011a) Food Corporation of India, http://fciweb.nic.in/ (accessed on 7 February
2011).
FCI (2011b) Statement Showing Allotment and Offtake Under Different Schemes,
FCIWEB.NIC.IN/SALES/VIEW/5 (accessed on 7 February 2011).
Jha, S., P.V.Srinivisan and M. Landes (2007) ‘Indian Wheat and Rice Sector Policies
and the Implications of Reform’ USDA Research Report, No. 41. USDA
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Khera, R. (2010) ‘India’s Public Distribution System: Utilization and Impact’ Journal
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Economic Research Service, USDA, Washington.
Ramaswami, B. (2002) ‘Efficiency and Equity of Food Market Interventions’
Economic and Political Weekly (Mumbai) March 23, 2002.
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http://www.isid.ac.in/~bharat/dstamps.html
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32
(accessed
on
10
DATA APPENDIX
The behavioural equations are:
p1  a1  b1Q1  Q1 : inverse demand for domestic product
p2  a2  Q1  b2Q2 : inverse demand for imported product
pA  f  kQ1 : inverse domestic supply function
pw F  KQ2 : inverse import supply function
The data and elasticities that were used to calibrate these supply and demand are as
follows.
price elasticity of demand = 1
elasticity of substitution = 2.2
consumer price domestically procured wheat = Rs15670/tonne
consumer price of imported wheat = Rs15008/tonne
quantity of domestically procured wheat = 80,560,000 metric tonnes:
of which the quantity procured by the FCI for its various welfare
programmes is 31.38484 million tonnes;
and of this procurement, 22.384 million tonnes is allocated to these
programmes;
the difference us assumed to go into the buffer stock; and
the buffer stock norm is 8.2 million tonnes
quantity of imported wheat = 290,000 metric tonnes
price elasticity of supply of domestic wheat =0.5
price elasticity of supply of imported wheat = 10
supply price of domestic wheat = MSP = Rs10,800/tonne
supply price of imported wheat = Rs13,400/tonne
In addition, a number of accounting identities were used to calculate the budgetary
costs of the various policy instruments.
33